You are here

Big bang for startup 'crowdfunding' opens with a fizzle

[SAN FRANCISCO] Everyday investors can finally buy shares in private startups, but so far "crowdfunding" is off to a slow start.

After new investment rules came into effect this week that allow anyone to invest in private companies, only around three dozen startups - including a distillery and a donut store - were peddling stakes to the public on nine funding websites by Wednesday morning, according to news site Crowdfund Insider.

Although it is still early days, the reaction to the long-awaited regulation change has been weaker than expected. Entrepreneurs blame high participation costs, overly burdensome regulation, and a general mood of caution among investors.

"I'm a little bit disappointed in how this has played out," said Chance Barnett, chief executive of Los Angeles-based Crowdfunder, a site serving wealthy investors that is applying to regulators to add less-privileged backers to the mix. "It's not going to be significantly transformative."

US Congress passed a law four years ago that loosened longstanding rules restricting investment in private companies to "accredited investors," generally people with a net worth of US$1 million or more. Supporters of the law, known as the Jobs Act, argued that it would spur a rush of dollars into startup companies and give the economy a boost.

But it took years for the US Securities and Exchange Commission to draft regulations for what is now known as equity crowdfunding. The launch comes as even professional venture capitalists have grown more cautious about startups.

Mr Barnett estimates that the cost of complying with the new rules can run from US$50,000 to $US200,000, a large sum for most startups, and a good chunk of the maximum of US$1 million per year that they can raise through crowdfunding.

Startups must disclose financial statements to investors, meaning any competitor could simply invest a few thousand dollars and gain valuable insights into a rival. "The rulemaking process seems to have completely butchered and gutted the JOBS Act's intent," said Daniel Zimmermann, an attorney at law firm WilmerHale.

There are some signs of pent-up demand. At Wefunder, which has 17 companies so far listing stakes on its site, about 48,000 non-accredited investors have signed up over the past few years, said Mike Norman, co-founder and president.

Traffic on Wefunder was so busy on Monday that web pages failed to load. By Monday night, the problems had been resolved, the company said.

Bioengineering startup TAXA Biotechnologies managed to raise nearly US$50,000 on Wefunder by Tuesday night, according to CEO Antony Evans. His company, founded three years ago, is using genetic engineering to create plants that glow in the dark, and is aiming to raise at least US$400,000 in the next 90 days. The company can keep the money it raises only if it reaches its goal.

Before Wefunder, TAXA had already raised nearly $1 million through the startup coaching program known as Y Combinator, angel investments and pre-orders for its plants through Kickstarter, another crowdfunding platform. On Kickstarter, supporters cannot take equity stakes, but typically snag samples of the merchandise in exchange for donations.

Crowdfunding can fill an important hole for companies not yet big enough for an initial round of venture capital funding, which averaged US$7.8 million in February, according to research firm CB Insights. "We aren't ready for that," Evans said.

"We've not hit enough of our product milestones." That is also the case for Bloomery Plantation Distillery, a small West Virginia-based liqueur maker aiming to raise more than US$300,000 in the next few months via Wefunder. Because Kickstarter forbids offering alcohol as a reward, that site was not an option.

Crowdfunding has been permitted for years in much of Europe. FundedByMe, a Swedish crowdfunding site, has helped about 100 companies find equity funding since 2012, said chief executive Daniel Daboczy.

And in Texas, crowdfunding of startups has been permitted under state law since 2014, but so far without a rush of either investors or companies tapping it, said Danny Kelman, chief executive of Dallas-based CrowdBoarders.

Mr Barnett at Crowdfunder said he was still "passionate about democratizing the opportunity to invest in early-stage companies."

REUTERS