NEW YORK (MainStreet) — In this age of high-profile tech news — from recent IPO filings for Alibaba and Box to speculation that Gilt Groupe could pursue an initial public offering — the era of the flashy tech IPO is far from dead. But a growing movement raises the question of whether grassroots fundraising has the potential to uproot traditional models of startup funding, and whether that will democratize the process of IPO investing.
The biggest change in the landscape comes in the form of legislation: "Currently, only accredited investors can buy equity in startups," as CNN Money explains. "The JOBS Act, which passed in early 2012, has legalized equity crowdfunding for regular Joe investors, but the SEC hasn't yet finalized its rules for implementing the law." Understandably, that leads to a lot of excitement, speculation and doubt.
Once the SEC finishes its rulebook on what it means for regular people to invest in startups, that opens the door for existing equity crowdfunding platforms like CircleUp, Fundable, SoMoLend and Alphaworks.
At Internet Week New York 2014, Lauren Young, money editor at Thompson Reuters, moderated a panel on this topic, featuring Annemarie Tierney, general counsel at Second Market, which helps private companies streamline financial transactions and communicate with stakeholders; Barry Schneider, CEO of Loyal3, a technology platform to enable regular people to invest in companies' IPOs; and Nick Chirls, Head of Alphaworks.
Historically, Schneider says, there has been tension between companies' access to capital and investor protections. "When you look at the 2008 crisis, investor protection was really high and access to capital really low," Schneider said. "Then there was more access to capital, but investor protection went down. Our goal is to provide access to capital and investor protection."
The JOBS Act will change a great deal for investors hoping to put their money behind their favorite startups. Back around 2010, Tierney says, Facebook struggled with the prospect of undergoing an IPO because of its growing number of shareholders, such as early employees and those who bought Facebook shares privately.
"At that time if you had over 500 shareholders you had to have an IPO," she says. "Sometimes a company doesn't want to be public. It's expensive and a lot of liability. So we started advocating in Congress around that 500 shareholder number, and the JOBS Act raised it from 500 to 2,000. We're really proud of that."
The Murky Boundaries of a TBD Law
The law, which has yet to be fleshed out, leaves a lot unknown about the future, but in the meantime, investors can tap into startup investing if they're accredited. The concept of accredited investors has "existed for half a century or more," says Chirls, "and it's out of date when you look at how people raise capital these days. They're high net worth individuals, but that doesn't make sense when you're a bootstrapped startup."
Until the JOBS Act's sanction of crowdfunding for equity is finalized, the lines between contributing, social support and actual investor rights can be murky. One good example is the recent purchase of Oculus Rift by Facebook, which upset some early supporters of the product. "Oculus had extremely engaged third-party developers who kind of felt like they had ownership of the company because they participated in Kickstarter," says Chirls. "That's not Kickstarter's fault, but there was a gap in expectations—they were backing the company on Kickstarter and felt like they had a long-term relationship with the company, but Oculus quickly spun that into a large raise and acquisition by Facebook. It would have been so interesting if we could have seen Oculus opening funding to developers."
The Hurdle—and Beauty—of Mom and Pop Investors
Broad interest among regular retail investors in their favorite companies' IPOs is definitely there, Schneider says.
"It's easy for people to invest in things they love," he says.
Ideally, he says, all people with brokerage accounts would have the opportunity to invest in the startups they care about, but most don't, because it's difficult and expensive to purchase stocks in smaller quantities.
"We think a really good area of democratization is in the idea of the way an IPO is structured," Schneider says. "It's supposed to provide a discount of 15 percent to the market. Who gets that access? Wall Street and their biggest investors. We thought, 'How fun would it be if we tackled that and allowed access for everyone to IPOs?' . . . We went to work in 2011 and got approval last year to crowdsource IPOs. If 10 million who people care about a brand put in $100, you'd raise a billion."
Of course, serving lots of small-time investors can be challenging for the companies themselves.
"Crowdfunding is a good idea in some ways but not in others," Tierney says. "I saw this really cool entrepreneur speak at a conference a couple years ago . . . and she was saving she would never take advantage of crowdfunding, because she doesn't want to deal with a thousand investors who have one to three shares apiece. Some unsophisticated investors have un-meet-able expectations, and those can be expensive to service. When you invest, the company has to send you things, you have to vote, proxy statements and so on."
All the same, Schneider says, retail investors provide companies with certain benefits. First, regular consumers often choose to invest in a company, because they have a real relationship with the product. Looking at data from Loyal3, he says, "For a company trading stock for two years, 90% of [retail investors using Loyal3's platform] with that stock haven't sold it. Every single month they're buying stock — 64% give us authority to automatically every month."
The company has finished three IPOs on its platform to date, and at end of day, for those three, about 2% sold on the first day. At end of 30 days, 90% of people still held that IPO stock. That's really tremendous."
Retail investors personally engage with their brands of choice more closely than average consumers. Data shows that people who own stock directly are visiting the company's websites and stores more and referring customers two times as often as regular consumers, according to Schneider.
"This is an awesome time to be in the financial business because we trailed the rest of the world," Schneider says. "Before this, retail had been democratized, or entertainment, or politics. But [the financial sector is] the caboose because of this heavily regulated feeling. But truth is that in terms of social, technological and regulatory awareness, this has given us a chance to provide efficiency and democratization to this sector."
Another benefit of working with smaller retail investors, Tierney says, is that some less-buzzy companies can garner investor interest more easily.
"When trading Facebook shares there was huge interest, but when dealing with lesser-known companies, not the top 15 to 20 really well known pre-IPO tech companies, it can be harder to find buyers," Tierney says. "So you can shift your model . . . [New technology to allow investors to interface more directly with companies is] disruptive because everything is done electronically, and so much time is saved, and paperwork."
Chirls notes that investing is coming to mean something new as time goes on. Currently, he says, investing is "about ownership." But new words are cropping up that reflect a changing infrastructure: "For example, a cooperatively owned business: What does that mean? As we see investing open up, your dream of participating in investment for companies you care about will become possible."
--Written by Allison Kade for MainStreet