Issuers revert to Crowdfunding and other alternative methods of raising capital

PreIPOSwap.com — 4/3/2023 — New York, NY — 2023 has been a dramatic year for the VC industry.  Last year, in 2022, public markets experienced a significant correction which spilled over into private markets.  Many professional investors such as funds, were seeing great bargains in public equities and so diverted attention there.  Also, simply due to just capital loss, funds had less ‘dry powder’ or available cash to invest, so this was part of the reason that VC investing dried up.  In their words, some VCs see a ‘mass extinction event’ happening for the industry, read about it here:

Leading venture capital players are predicting a “mass extinction event” for early- and mid-stage startups that will make the global fiscal collapse in 2008 “look quaint” by comparison. According to Globest, a new survey has found that 81% of early-stage startups are facing a failure in 2023 because–as of the end of October–they had less than 12 months of capital left to keep going because VC funds turned the spigot off last year on a flood of seed funding.  An international survey of 450 startup founders in the US and Europe was conducted between August and October 2022 by research firm January Ventures, with 61% of respondents from the US and 32% from Europe. The founders who participated in the survey also were categorized by the level of funding for the startup: 48% of respondents said they had raised pre-seed funding, 32% said they had raised seed funding and 16% hadn’t started raising funding.  The survey found that four out of five startups are at risk of failure this year, with less than 12 months of “runway” left–defined as “enough capital to keep the lights on” (in the dot.com era they called this a “burn rate,” a reference to the amount of VC capital a startup was burning through before generating any revenue).

The issue is exacerbated by the fact that many startups are addicted to fresh capital until they reach ‘escape velocity’ and can live on their own.  VCs have the tendency to throw more capital at something that looks like it’s going to fail (in addition to bringing in their own advisors, etc.).  But that strategy depends on VCs having deep pockets, and this environment is changing their mentality.  Some VCs are even doing their rounds with their portfolio companies giving them cost cutting advice, trying to keep them from needing additional funds.

Issuers are seeking other methods of raising capital, such as Crowdfunding.  Substack recently raised funds via Crowdfunding successfully:

Substack is initiating a crowdsourcing funding round, allowing writers to invest as little as $100 in the company. On Tuesday morning, the startup emailed writers about the investment opportunity. The development comes amidst a freeze in venture capital funding markets, which followed the collapse of Silicon Valley Bank.  “Today, we’re starting a process that will let writers and readers invest in Substack and own a piece of the company. We are serious about building Substack with writers and readers and this community round is one way to concretize that ideal,” the email said.

In many respects, Crowdfunding is at odds with the VC community.  The VC model started out by VCs just investing their own money with their rich friends, and they pooled their investments into LLCs for efficiency, and for a single point of management.  Why work, when you can hire a GP to sit in an office all day when you want to be out on the Golf Course?  But it evolved into something much more granular, investors wanted the same access the VCs had, so VCs became gatekeepers to startup funding.  If Kleiner Perkins invests, it’s almost guaranteed you can get money from other VCs or from retail investors.

Many investors in the private sphere invest only based on who is on the cap table, or in other words, if Sequoia invested, I will invest (replace Sequoia with any number of big name VCs).  Crowdfunding places the issuer direct to consumer, cutting out the VCs.  Crowdfunding platforms are mostly managed by registered Broker-Dealers, so it’s not exactly cutting out the middle man.  The huge difference is that in the Crowdfunding world, the majority use software platforms that look and feel like cap-raise social media.  This provides a good user experience (UI) and enables semi-automation for the huge volumes of investors that can come through the door, on something like substack.

Venture Capital Cross (VCC) is the latest organization to start a funding portal with the explicit purpose of Crowdfunding (although, they are also going to do Reg D, Reg A+, and Secondary’s).  VCC is a doing business as or “DBA” of COVA Capital Partners, LLC – a FINRA registered Broker Dealer.  Crowdfunding is more like a software tool, where the BD can put the issuer in front of investors directly.  Traditional VC cap raise is similar to investment banking, it’s more of a roadshow/relationship type of business.  Perhaps in the future these 2 models will not be at odds with each other.  At least some groups, such as VCC, are launching a hybrid model with the hope of combining the best of both worlds.

With the success of Substack and other recent Crowdfunding campaigns, it looks as if the success of crowdfunding will continue at least for the foreseeable future.  What’s not clear is how this will impact the VC funding model in the long term.  10 years ago, no one could have imagined that major Wall St. banks would send workers to work from home remotely, and then refuse to come back to the office (in some cases).  “COVID” Changed the world forever, in how we work, how we meet, how we live, travel, and do business.  The landscape is still rapidly evolving, and new innovations are already starting to change market dynamics for the better.

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