There is no shortage of opinions or predictions on the markets these days—but at DealMaker, we have a direct line to some of the industry’s leading experts, like Sherwood “Woodie” Neiss. Woodie is Principal and Chief Data Analyst at Crowdfund Capital Advisors, and was one of the key players who pioneered the passage of the JOBS Act.
In light of current events and market turbulence, we were lucky to get some of his time to ask a few key questions about the crowdfunding ecosystem and where it’s headed, in both the short and long term.
DealMaker: Given your market analysis on Regulation Crowdfunding in 2022, what are some of your predictions regarding growth in the space for 2023?
Woodie Neiss: We all saw a slight decrease in Q1 for Regulation Crowdfunding. A pullback is to be expected because what happens in the public markets trickles down to the private capital markets, so I wasn’t surprised by that. SVB noise didn’t help, but if you dig into the numbers, it tells you a different story. While there was less overall capital that was deployed, you’ll see that the average check size increased. So what does this mean? I think it means that these investors are willing to make larger bets. So there might be a pullback downmarket, for new retail investors that are more skeptical about all investments, but those that are in it are in it to win. I’m confident it’s going to stay that way.
DealMaker: What do you say about the swirling predictions of a recession?
Woodie Neiss: Institutional money is definitely playing it more safe—we’ve all seen that VCs are keeping their portcos afloat and new funding has become quite scarce. And this is why crowdfunding is so crucial. This is the biggest test for the industry to date. Startups need cash and savvy founders will figure out that building their brand with a Reg CF or Reg A raise could generate both customers and investors. Now the cost of capital is the next question—debt versus equity. All of a sudden, founders need a strong understanding of cost of capital and great people in their court to help them navigate their funding round in this market. Can equity crowdfunding substitute for VC? Will it be able to deploy the same type of capital into the market? That remains to be seen. I think it’s critical for the CF cap to be raised.
DealMaker: What is your position on some of Congress and the SEC’s regulatory commentary as of late?
Woodie Neiss: If you’re referring to SVB—for the smaller banks, it’s tough. The level of scrutiny and regulation that you put on a large institution doesn’t always scale easily to smaller ones; the burden can put them out of business. That being said, it defies logic for banks to not have enough cash on hand—but also there was a bit of a bank run that was unforeseen, so there is a balance there with FDIC insurance possibly. But for Regulation Crowdfunding, I think the $5M cap should be lifted to $15M or $20M. Then you’ll see equity crowdfunding start to fill the gap that VCs are leaving—and they are leaving a lot of really great startups unfunded because they don’t quite ‘fit’ within their parameters. This also skews the types of unicorns… and look what happened there; a lot of inflated valuations because of the darling ‘unicorn’ status from VCs. It feels like a market dip, but it could really simply be a market correction or right-sizing.
DealMaker: There is a lot of market noise around the cost of capital and comparing those. Can you speak to that a bit?
Woodie Neiss: There is a lot of competition taking place in the industry right now, which is great for founders if they understand it. You guys are a perfect example. If you don’t want to go to a “portal” like StartEngine and pay up to 9% of fees on your money, you can go to a broker-dealer that specializes in this and work with them. The portals are easy to understand, but after all is said and done the cost of the capital may not work in the founders’ favor. And the conversation around equity versus debt—you know, if you are a hyper-growth type of business with exit potential, equity is where it’s at. Whereas in the debt scenario, you really have to prove that your cash flows are sufficient enough and historically there in order for you to cover the debt. So, those decisions are more about where the startup is and less about the cost comparison of either, in my opinion.
The reality I’m seeing in the industry is that there’s plenty of debt offerings, but I’ve not seen anything big, like a $5M debt offering. That’s why a funding round with retail investors could be such a game-changer for some of these startups. They don’t need to think about a bridge loan; they should be thinking about scaling their runway.
I analyze over 7,000 offerings and in 2016, 19% of the companies participating in equity crowdfunding were pre-revenue startups. Fast forward to today: 38% of all of the companies that are raising capital via crowdfunding are established (older than 3 years) and have revenue greater than $1M.
That’s an incredibly interesting shift in the types of risk retail investors used to see versus today. So, although the game hasn’t changed I’m seeing a positive shift. As the VCs move upstream, so will Regulation Crowdfunding. And retail investors, for the first time in history, can come in early and make some real money.
DealMaker: What would you recommend regulatory and governing bodies focus on, if you could sway them?
Woodie Neiss: There has been one SEC enforcement case against an investment crowdfunding issuer in the entire time of this industry. One over 11 years. That’s a very good fraud rate. Now look at the public markets, look at the Bernie Madoffs, the Enrons, it’s a much larger issue with more significant fallout. Through Regulation Crowdfunding, the mandated disclosure makes it just so unappealing to commit fraud - the time and cost it would take to try to pull the wool over investors is substantial. So the Reg CF cap needs to be $20M. We need to allow these issuers access to capital to scale—and most startups are doing some incredible things.
Also, I think the SEC should take pride in the work they did to have a framework of an industry with such a good fraud track record—but now they need to aggressively be promoting it. There is a huge educational void for founders to understand that there are more options than just VC and institutional funding.
The foregoing is market commentary only. Any market participant should do their own research and make informed decisions with their own advisors to make sure the particulars of their capital raise are correct for that particular issuer in that circumstance.