What use is an accelerator?

I recently was asked whether an early stage company should consider equity crowdfunding, and also whether venture capital investors would be put off by the fact that a company has used equity crowdfunding.

The answers to those questions remain in flux, but I think crowdfunding (especially angel-led crowdfunding) is an option that some early stage companies should consider.

Here are factors I find relevant:

How are you proposing to use crowdfunding?

I believe that crowdfunding is particularly suitable in the following circumstances:

  • You are doing a business angel round, have a significant level of the round committed, and need help in completing the round
  • You are in a business vertical that is not well supported by early stage venture capital firms in your local market. For example, I find that hardware and healthtech/life science businesses can find it particularly difficult to obtain early stage venture capital financing in Europe.
  • You are in a consumer business where crowdfunding may help you build a network of supporters for your business and product
  • You are in a business vertical that has “curb appeal” for the types of investors on the particular platform

What crowdfunding platform are you proposing to use?

All crowdfunding platforms are not alike. Some are focused on investment by business angels, and are efficient mechanism for pulling together angel syndicates. Others are focused on high net worth individuals. Others may have a broader retail appeal.

Investors. I have a prejudice in favour of angel and high net worth crowdfunding platforms. Investment in early stage businesses is very high risk (except, perhaps, on a very broad portfolio basis). I’m not keen on platforms that may appeal to potential investors who are not sophisticated and cannot afford to lose the money that they are investing.

Diligence. I also have a prejudice in favour of crowdfunding platforms that perform significant business due diligence and are selective as to the businesses that they list. That curating process may result in better companies being listed, which benefits both the investors and, reputationally, the companies.

Valuation. Additionally, it is important that the platforms exercise some discipline over valuation, for purposes of protecting the companies as well as the investors. An over-valued crowdfunded tranche may make it very difficult for a company to fund future rounds of investment –a subsequent down-round, or even a flat round, can be highly-damaging.

Specialization. Furthermore, some platforms have developed particular specialities, and have the technical expertise (either internally or through sector specialists who are prepared to act as lead investors) to evaluate businesses in that sector. Investors who have confidence in the technical curation, particularly in areas where they lack the relevant technical expertise, are more likely to invest, and the listed businesses are more likely to be successful.

Success. Last but not least, you should look at the success that the platform has had in completing investment rounds, and the extent to which completed rounds have had to be downsized.

General Reputation. All of these points feed into the general reputation of the crowdfunding platform. Your brand is affected by the company you keep, and this applies to your choice of crowdfunding platform as well as in other contexts. As time passes, more information is becoming available as to the investment performance of companies on the various platforms (or, at least, in respect of those platforms that provide transparency). This can be expected to affect the reputation of the platforms over time.

Where is your company based?

European early stage venture capital investors may be more willing to accept a crowd-funded tranche of investors beneath them, simply because: (a) broad-based equity crowdfunding has been around longer in Europe (until 2016, the US equity crowd-funding market was largely limited to accredited investors); and (b) early stage funding from venture capital firms, business angels and other sources has been more difficult to obtain in Europe than in the United States, particularly in certain verticals.

How does the crowdfunding platform manage the capital raise, and also manage crowdfunded investors after the raise?

Founders need to understand how the crowdfunding platform will deal with the technical aspects of the raise, including due diligence and documentation, and over what timeline.

Additionally, founders should focus on the extent to which, and how well, the crowdfunding platform will continue to manage the pool of crowdfunded investors after the capital raise is completed. A key disadvantage of equity crowdfunding is that it can result in your having a large number of investors in your cap table. Dealing with these investors, from the standpoint of keeping them informed and, particularly, securing investor consents, can be very painful unless there is a nominee, lead angel or other structure whereby a single party can act on behalf of the pool of crowd-funded investors.

Furthermore, if the quality of the crowdfunding platform’s documentation is not very good, this can cause problems when the next group of investors comes along and requires significant revisions.

In my experience, concern about these issues has been a significant reason why some venture capital firms have been wary of investing in companies that have had a crowdfunded tranche of investment. If you anticipate that you will need to rely on subsequent venture capital funded rounds, you should speak with potential VC investors as to their views on your using an earlier crowdfunded tranche.

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This discussion is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions or comments, feel free to contact robert.mollen@friedfrank.com or via LinkedIn here.

You will find Bob’s blogs for emerging and growth companies on US issues, international expansion and early stage financing here: http://bit.ly/2lP5uMP