On Monday, the SEC’s new startup investing rules went into effect. Startups can now raise $5 million annually through equity crowdfunding. That’s a 5x increase from the previous limit.
I really can’t overstate how important this change is. It’s a monumental moment for startups — and everyday investors like you and me. Suddenly, equity crowdfunding is a viable funding option for far more startups and small businesses. The new limit is enough to to fund a large seed round or a moderately-sized Series A.
Word is spreading among founder networks that “equity crowdfunding” now deserves serious consideration. It’s now possible to raise $5M from 10,000 investors in $500 chunks. Think about the potential benefits of having a small army of investors supporting an early-stage company.
For startups that sell consumer products, it’s a vast group of potential early customers (and a way to offer current customers a stake in the business). This battalion of investors can help get the word out about the company’s product by sharing on social media and referring friends. And with up to 10,000 investors, the group is bound to have a diverse set of skills that can help in all sorts of ways — from marketers to writers, lawyers, designers, developers and sales people.
For many startups, these funding rounds will increasingly serve not just as a funding mechanism, but also as a marketing one. Whether the product targets consumers or businesses, the potential benefits of conducting a public funding round are tremendous. If the campaign catches on, it’s likely that hundreds of thousands of people will learn about the company and its offerings.
First Real Competition For VCs
One of the more interesting aspects of this new paradigm is that for the first time ever, early-stage venture capitalists have real competition. They’re no longer the only viable option for early funding rounds.
Don’t get me wrong, there will always be a role for talented venture capital firms. They back many of the most successful businesses in the world — and will continue to do so. But the business model just doesn’t scale well. There’s only so many deals each partner and firm can back.
The other big problem is that VC money tends to concentrate in a handful of big cities (New York, San Francisco, Boston, etc). Most VCs only invest locally. They don’t bother with the rest of the country.
Outside of these few big VC cities it’s been incredibly difficult to fund startups — until now.
Equity crowdfunding has no geographic restrictions. Talented founders from any state, city or town in the U.S. can now raise a substantial round of funding online. All they need is a promising business and the ability to get investors excited.
Equity crowdfunding also has the potential to scale extremely well (unlike VC). The big funding portals have streamlined their operations over the years and are now hosting hundreds of deals between them on any given day. With the new $5M limit on Regulation Crowdfunding (Reg CF) deals, the sky’s the limit in terms of growth. Here are the portals I check most frequently:
Startup investors will see some truly impressive deals over the next few months and years. I expect that many will sell out quickly. And eventually, the SEC will realize that even $5 million isn’t enough. Hopefully then the funding limit will be raised further — perhaps to $20 million or more.
After all, companies can raise unlimited amounts of funding from accredited investors, with essentially no regulations at all. Once everyone becomes comfortable with the $5M Reg CF limit, I think it’s only natural that it will grow over time.
There’s also Regulation A+ (Reg A+), a funding option which now allows companies to raise up to $75 million. This is a nice option to have, and I expect there to be some interesting Reg A+ deals in the near future. But the legal and financial requirements for the startups are pretty onerous. It’s practically like going public. I think Reg CF is the ideal future of early-stage capital formation. Its requirements are serious enough to deter bad actors while still being achievable for anyone who is committed to raising.
The $5M limit change is huge, as will become increasingly clear over the next year. Today, I’m reasonably sure that VCs don’t view equity crowdfunding as a real competitor. But I’m just as confident that over time, they will realize that the competitive threat is real. The power of the crowd will be on full display going forward.