Institutional vs. Crowdfunding
I am a big proponent of crowdfunding. Unfortunately, equity crowdfunding is still experiencing the growing pains of a nascent industry. That does not mean the promise of crowdfunding as a better, more efficient means of capital formation remains unfulfilled. I am yet hopeful the future is bright, particularly when it comes to feeding the ever-present funding need in the middle market. Even with the promise of the future and my positive view on the potential of equity crowdfunding, I still maintain the belief that institutional investors hold the “straight flush” over the crowd when it comes to raising capital.
Institutions Are Professional Investors
Perhaps the greatest change implemented as part of the JOBS Act was the ability to generally solicit. While this helps to broadly distribute information on a particular deal, it does not necessarily guarantee even the most well-advertised deals will be fully subscribed from the crowd. General solicitation–including the “post and pray” fever brought on by the litany of endless deal portals–has yet to display the blessed promise many anticipated. Deals will always need to be sold, especially when it comes to individual accredited investors.
Fundamental differences exist betwixt individual accredited investors and institutions. First, institutions and their managers are professional investors. They are accustomed to regularly seeing and investing in deals. Many of them are paid for doing so. It is quite literally their jobs. The same cannot be said for the majority of individual accredited investors. Most individual investors are less focused on deals and more difficult to corral. Professional investors are focused on regularly and repeatedly sourcing, vetting and closing more deals. Unfortunately, individual investors often lack the same focus.
While many existing deal platforms claim thousands of registered, individual investors a much smaller percentage are likely to pursue the pantheon of opportunities that are and will be published online.
Wealth Concentration & The 1%
When Willie Sutton was asked why he robbed banks, he said simply, “Because that’s where the money is.” The same could be said when describing potential investors for in a potential deal, whether crowdfunding or otherwise. The same statistics describing income inequality could be used to drive home the point being made here. Private equity groups, family offices and venture funds have access to a much greater pool of overall capital. It is likely a safe assumption that if Willie Sutton had been an investment banker, he would have focused on institutional money.
Investor Liability & Culpability
When regulators write and enforce securities laws, they tend to focus their efforts on protecting individual investors. The world of 506(b) private placements was intended to protect general solicitation toward and collecting funds from non-accredited investors who may lack the sophistication necessary to make prudent investing decisions. Such investors may also lack the ability to sustain large losses in a relatively limited (and often illiquid) portfolio of private stocks.
The next level of scrutiny involves private transactions with accredited investors. While accredited investors may be considered more sophisticated under securities laws, securities sold to them are still treated with a different level of scrutiny than institutional-grade individuals or funds where multiple fund managers, accountants and advisors tend to assess and make decisions in an overall portfolio. The better equipped one is at making an investment decision, the less scrutiny is likely to be applied in assessing the overall customer suitability question. It is for this reason why many investment banks rely solely on institutional contacts when pitching and closing deals.
Crowdfunding involves corralling the proverbial cats to get an investment round fully-subscribed. This typically means many more phone calls, emails and general outreach–thanks now to general solicitation with 506(c). It also means the speed of the transaction can be significantly protracted.
When it comes to raising capital, prolonged timing is the enemy to success and transaction closure. Fortunately, in many cases involving institutional investors, speed is at least one key feature and byproduct of larger funds. While due diligence can be longer in institutional-based investing, speed to a fully-subscribed capital raise is easier when one or a small handful of venture, private equity or family office funds make a sizable investment, often with a single inked check.
The Best Deals Are Rarely Published Broadly
Some of the best deals an investor will ever see are rarely published broadly. The best deals do not require “general solicitation” or “the crowd.” Often done with a wink and a nod between the issuer and the money source, such transactions typically occur infrequently and very far outside the public view. Deal platforms hope to provide greater access to volume, but most investors are seeking quality over quantity and unless a platform is looking to curate deals and pitch them in a more structured way to strategic institutions, even quality deals may become lost in the endless barrage of dealflow.
Raising capital is certainly never easy. Raising capital still requires a relationship-focused approach between the issuer and the investor–something that crowdfunding can sometimes miss. In addition, the simple fact that a deal is listed as a 506(c) private placement may actually deter the glances of the best institutions looking for a great deal. Crowdfunding may still hold the key to the golden goose for middle-market financing, but until crowdfunding can grow up and move out of the house, institutions will continue to trump the crowd when it comes to raising money more efficiently. The trump is likely to hold for some time into the future.
Nate Nead is a Principal at InvestmentBank.com. A licensed investment banker, Nate works with individual issuers and investors at finding solutions for everything from sell-side M&A to capital financing for targeted transactions. Securities are offered through Offerboard Securities. Nate loves all things fintech. He resides in Seattle, Washington. This does not represent an offer to buy or sell securities.Like This Post