Ing Platforms (Such As Crowd- a PHASE Funding) Become a Flood? in THE
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Will the stream of new funding platforms (such as crowd- funding) become a flood? A PHASE IN THE CBy Cynthia Harrington,R CFA OWD In finance, cracks in what seem like solid edifices can the market will grow to an estimated $300 bil- explode into catastrophic-sized holes. Here’s an analogy lion by 2025. For one, the JOBS Act makes every- that hydroelectric engineers will understand. A concrete one in the US a potential investor. Sixty-two per- cent of self-directed IRA investors report that slab called a spillway is built opposite all dams for emer- they either plan to or already have increased gency runoff. Rains in early 2017 caused the spillway in their allocation of non-traded alternatives in Oroville, California, to be used for the first time in its response to market volatility. Institutional inves- 48-year history. An enormous chunk fell out of the middle tor demand for alternatives is similarly growing. Preqin, a data and analysis firm for alternative of it, dropping water down into a three-story jagged hole assets, reports in its 2017 investor outlook that and diverting billions of gallons of water toward unsus- one-third of institutional investors have expo- pecting people’s homes below. sure to at least four alternative asset classes, up from one-quarter just a year ago. The main culprit is suspected to be cavita- Both the demand and the supply sides of the tion—the formation of a cavity within a solid still-nascent crowdfunding marketplace are object. The process begins with water pound- flowing strong. There is a generous supply of ing over the small imperfections in the formed companies looking for funding, and in smaller concrete, which creates tiny water vapor bubbles amounts. Such technologies as cloud computing that collapse like a horde of jackhammers. We and open-source software, as well as dynamic may be on the brink of a similar collapse with languages like Ruby and JavaScript, make it the changes in small- and emerging-growth cheap to get a company started. What used to company financing. take tens of millions of dollars can be accom- plished for hundreds of thousands. Lots of new TRULY PUBLIC OFFERINGS companies plus lower capital requirements With the signing of the Jumpstart Our Business Start-ups (JOBS) Act five years ago, companies Cumulative # of Regulation Crowdfunding needing capital became able to solicit investors Offerings Filed with SEC directly. Reportedly, almost $3 billion flowed 240 to new companies from accredited investors in that first year. “Title II [accredited investors] 180 came out like a rocket ship when the act was signed in 2012,” says Matthew R. Nutting, who 120 practices corporate law at Fresno, California, law firm Coleman & Horowitt and is a direc- 60 tor of the National Crowdfunding Association. “There were few publicly traded offerings then 0 and lots of money chasing those deals.” 6/1/2016 8/1/2016 10/1/2016 12/1/2016 2/1/2017 According to CFX Markets, a trading platform Source: www.crowdfundcapitaladvisors.com/ for alternative assets, there are several reasons cca-regulation-crowdfunding-indices 48 CFA Institute Magazine June 2017 equals a great opportunity for hundreds of millions of meetings, expensive directors’ insurance, and pressures to potential investors. favor short-term results over long-term strategy. Despite the pent-up demand for investments and capital, Benefits are given in equal measure as requirements are Nutting adds a note of caution: “I think Title III [of the JOBS diminished. Companies can communicate with qualified Act] is going to be a slow build.” Nutting, who also co-wrote institutional buyers or institutions of all accredited inves- a book on this new asset class called Equity Crowdfunding tors through the “test the waters” provision prior to pricing for Investors, believes the most recent changes to the JOBS to determine demand for the company’s securities. Research Act, which increase the potential size of deals and make reports on EGCs follow more liberal rules under the new crowdfunding available to as many as 240 million Ameri- laws than those that govern traditional IPOs. cans, will take time to find their place. The companies likely to be successful at marketing to the Advisers to institutions and high-net-worth individuals general public still follow a certain pattern. “Most compa- may want to take note of these tiny bubbles. For one, the nies are not marketing to the wealth manager or institu- supply of available companies trading on public exchanges tional investor yet,” says Mark Elenowitz, founder and CEO is half what it was two decades ago, bringing the total to of TriPoint Global Equities in New York City. “Companies just over 4,000. For another, this is where high-net-worth are presenting to an investor [who is] doing their own due and institutional dollars are going. Millennials notoriously diligence, and these investors have to understand what the avoid public markets, and the younger among them are company does in the first 30 seconds.” more likely to invest in their friends’ private start-ups than Elenowitz points to two such companies that have raised in public companies. The Facebook IPO, for example, made funds through his company’s crowdfunding platform, called 1,000 new millionaires. The pool of these investors is grow- BANQ®. The first is Yuengling, one of the oldest breweries in ing; if the near-10% annual rate continues, by the end of the US, which has huge brand awareness. When it launched 2017, there will be more than 9.5 million high-net-worth investors Growth of crowdfunding region prediction for 2015 in millions of USD in the United States, an increase (research based estimate) of 68% from 2012, with the total 210% wealth of this group increasing by $17.25bn 98.6% 83% to just under $40 trillion. While each country has its own $6.48bn $10.54bn rules, the US has lagged in facili- 82% tating crowdfunding for emerging companies, and the traditional ven- EUROPE ture-capital industry is taking note. 101% Crowdfunded deals raised $34 bil- NORTH AMERICA ASIA lion throughout 2015; this is catch- 59% ing up to the annual US venture- 50% $24.16m capital activity of $69 billion. $68.6m $85.74m AFRICA BEER, ICE CREAM, AND OCEANIA ROBOT ARMS SOUTH AMERICA Emerging growth companies 2015 Percent Annual Growth Rate (EGCs) are drawn to the new fund- 2015 Funding Volume ing streams for many reasons. Top on the list is the lower cost. An IPO’s Source: Massolution 2015CF Crowdfunding Industry Report start-up costs are in the millions; a JOBS Act business can get off the ground with investments a new product line of ice cream in 2014, its customer base of in the hundreds of thousands. Fewer filing and reporting 225,000 people (as well as its huge social media audience) requirements save time and money. According to the SEC, created demand for its shares through familiarity with and the JOBS Act provides “scaled disclosure provisions for passion for the products. A second company with appeal to emerging growth companies, including, among other things, the public is Myomo. Its exoskeleton robotic arm, built for two years of audited financial statements in the Securities people who have paralysis or MS that restricts arm mobil- Act registration statement for an initial public offering of ity, is highly visual. “Investors look on the site and see this common equity securities, the smaller reporting company device move a previously immobile arm, and they get it version of Item 402 of Regulation S-K, and no requirement immediately,” he explains. for Sarbanes–Oxley Act Section 404(b) auditor attestations For crowdfunding industry veterans, the process of con- of internal control over financial reporting.” Firms can avoid necting companies with the public for money started before the costly requirements associated with traditional IPOs, the JOBS Act. An industry report published by crowdsourc- such as disclosures of compensation for executives and board ing.org polled 135 crowdfunding platforms (CFPs) that were members, regular filings of Forms 10 and 8, stockholder already actively fundraising in 2010, before the JOBS Act June 2017 CFA Institute Magazine 49 was passed. These platforms created and tested the technol- Wefunder lists success stories for 153 companies rais- ogy for processing transactions and the methods to attract ing $34.5 million through Reg-D offerings. The deals are individual funders. Darren Marble, CEO of CrowdfundX in often done out of a personal passion or familiarity. An inves- Los Angeles, has led the marketing for more than 100 crowd- tor who lives in New York and likes beer could invest in a funding campaigns over the last seven years. microbrewery in Alabama or a brew-your-own bar in Boston. Marble, in typical start-up lingo, describes the gene- Another investor whose life has been touched by diabetes sis of his current company as having “failed into the busi- could find a company making a bionic pancreas that auto- ness” after two previous attempts, including a film-financ- monitors blood sugar levels to guide the release of insulin. ing effort. CrowdfundX, whose lead investor is Steven John- The craft brewery investor, doing due diligence, can see son, former chief investment officer of Apple, has at least that a particular beer maker has big-name customers and one claim to fame in the crowdfunding world. The com- good sales and enjoys first-mover advantage. Our diabetic pany designed, produced, and marketed the Regulation- investor might note that the bionic device was developed A+ equity-crowdfunding campaign for the first crowd- by a medical researcher for his son and that Eli Lilly has funded IPO in the US—Elio Motors, which raised $17 mil- made a $5 million investment ahead of the Reg-D offering.