Early Investing

Crowdfunding Keeps Getting Better Four Years In

Crowdfunding Keeps Getting Better Four Years In

Crowdfunding celebrated its fourth anniversary last week. The SEC greenlit it on May 16, 2016. A year before Regulation Crowdfunding (better known as Reg. CF) began, the SEC began to allow companies to raise funds under Regulation A+ (Reg. A+). But startups needed considerable money and time to comply with SEC requirements for Reg. A+. Deal flow was slow and the quality of startups raising funds was mixed.

Regulation Crowdfunding (better known as Reg. CF) was faster and sleeker. Minimum investments were also much smaller. Reg. CF soon became the preferred choice for startups and investors alike.

At four years old, crowdfunding is still in its infancy. But a lot has already happened. As the co-founder of Early Investing, I’ve been an active participant in helping investors take advantage of crowdfunding opportunities. This position has given me a front-row seat to how it’s evolved through the years. And over the next two weeks, I’m sharing my top 10 observations about crowdfunding’s past and future. Here are my first five…

1. Startup returns are rising. Stock returns — not so much. Crowdfunding began in a bull market that was basically floating all boats. Startup investing seemed like an unnecessarily risky proposition for the everyday investor. Early on, crowdfunding was widely unknown. It was more exotic than buying property in Bali. These days, most people know they can invest in startups. And they probably have friends who do invest. That’s progress.

But the biggest change? It’s the ballooning gap between returns from startup investing and from public stocks. Public stocks are significantly overvalued. That was painfully obvious even before COVID-19 crippled the economy. Stocks are even more of a losing proposition now. But startup investing is going in the opposite direction. The better startups will survive this recession. They’re selling at reduced prices right now, making their upsides if they hit even more attractive (10x to 50x).

We’re at a major crossroads. Investors who put money into startups will be on the right side of history. Others will regret not seizing this moment – where tremendous opportunity beckoned and the time was right

2. It’s no longer who you know. Before Reg. CF, startup investing was rigged to favor the connected. Those who went to the right schools… Or had family connections… Or who simply lived and worked in Silicon Valley. To invest you had to know somebody. Crowdfunding changed everything. Everyday investors could buy private startup shares for the first time.

Founders were also big winners. Founders with great startups but few connections didn’t have to beg unreceptive VC firms for money. Reg. CF democratized investing and raising capital. It’s the best thing to happen to investing since 30-year loans enabled home ownership en masse.

3. Affordable. Reputable. And high upside. Investors love cheap stocks. There’s something irresistible about paying pennies for a share. But penny stocks can easily be manipulated by unscrupulous investors who pump and dump (buy low, drive prices up, and then sell at inflated profits). Early-stage shares are just as inexpensive. But the price is set into place once a crowdfunding raise begins. It can’t be manipulated up or down.

Four years ago, people worried that startups would be overrun by scammers. It never happened. The occasional scam does occur. Theranos’s founder lied about its technology, and VC investors lost millions. But it’s been for the most part a non-issue.

4. Better and better. Crowdfunders have put $300 million in startups since Reg. CF began. And every year more capital is raised through crowdfunding. But the numbers tell only half the story. The quality of startups keeps improving. That drives the capital increases we’re seeing. Four years ago, it was a challenge to find a great startup to recommend every month. Now I’m recommending two a month. And there are many incredibly worthy startups getting left out.

Some credit goes to the investment platforms. These portals are getting better at identifying startups worth investing in and culling out the weaker applicants. But they’re also just getting better startups to choose from. Startup quality has gotten better every year. It’s at a high level now. And with the emergence of exciting technology in medtech, robotics, AI and VR, there’s another level to reach. We’re entering a golden age of truly impactful startups. And many of them are choosing to raise from the crowd.

5. Less risk. More rewards. Investing in startups is a high-reward approach that comes with risk. It’s so early in the ballgame, you don’t know how that game will turn out. But when you invest in what you love and understand, you bring more knowledge and insight into the investment decision. The risk is not nearly as great anymore.

Peter Lynch, former head of the Fidelity Magellan Fund, was most responsible for spreading the tenet of investing in what you understand. He firmly believed that people’s greatest research tools were their eyes, ears and common sense. Many of his great stock picks were discovered while walking through the grocery store or chatting casually with friends and family. As customers and consumers, we perform our most effective product research. Founders embrace this idea with Reg. CF. They like nothing better than to turn their customers into investors (and vice versa). Lynch applied his idea to small caps. But it works even better with startups.

Next week I’ll discuss crowdfunding’s biggest challenge and why the best things about startup investing can also be the most frustrating things… So stay tuned.

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