Equity Crowdfunding vs. Reverse Mergers
I’ve seen the debate raging on both Investorshub, Linkedin and Twitter: should a company perform a reverse merger or vie for the equity crowdfunding route? It’s an interesting question which does not, unfortunately, have a overarching answer for each firm that may be weighing the pros and cons of each–and there are pros and cons of both. I would like to discuss a bit about the pros and cons of equity crowdfunding as well as some of the pros and cons of going public via a reverse merger. Each company considering one option over another should weigh out each scenario carefully asking whether the pros outweigh the cons. The eventual decision should be weighed against the backdrop of your individual company situation as well as the growth opportunities you’ll have with each scenario. I also want to paint a picture of what the world will look like with Title III equity crowdfunding–as it will change the decision and outcome for many a firm.
Pros of Equity Crowdfunding
- Lower cost. While the cost to go public is much lower than most people think.
- Easier promotion than before. Now that the ban on general solicitation has been lifted, companies are finding it easier to go out and promote their private placement to investors (accredited and otherwise). Just a note, promoting a public stock is much easier
- Increased exposure. Social media tools and internet viral campaigns can provide more rapid exposure than ever before for a private offering.
- Bypass venture capital. It’s easier to raise money more rapidly without giving away as many concessions to the venture capitalists. It’s a true democratization of capital.
Cons of Equity Crowdfunding
- The stock is not liquid. Once you’ve invested in a deal, your capital is locked. While the JOBS Act does allow you to sell your stock in a secondary market, no real quality secondary market for private shares exist, at least not one as efficient as the public markets. If investors want their money back, they’re likely be S.O.L.
- Only accredited investors. Once Title III of the JOBS Act is fully implemented, this may change, but as of right now, eligible investors include those with $1MM in assets above the value of their real estate or income of $200K+ per year for the last two years with the number expected to be maintained in future years.
We’ve rightly outlined the pros and cons of taking a private company public by a reverse merger before, but let me just outline some of the basics again.
Pros of Reverse Mergers
- Increased liquidity. The ease of raising and selling capital is greatly enhanced.
- Increased exposure. This is also a con.
- Better ability to use stock in transactions. If you’re performing mergers & acquisitions or industry consolidation, being public allows buyers to use stock as an efficient bargaining chip.
- Less Dilution than venture capital.
Cons of Reverse Mergers
- May not raise as much capital.
- Fraud is more of a temptation. We’ve seen this many times over which is one of the reasons reverse mergers have had such a bad rap.
- Greater exposure to liability and litigation. Public companies are sued more often than private companies.
- It costs more. Going public has a greater up front and on going cost than any equity crowdfund campaign. Overcoming the expense of this regulatory burden is easier than you think if you can find a good SOX-compliant accounting firm and savvy securities law firm.
I really like what John Taylor of the National Venture Capital Association said relating to crowdfunding:
If an entrepreneur walked into a venture capital firm with a great idea, or even a working prototype, but pointed out that they had 300 shareholders, that would probably be the kiss of death. You need to plan on day one if your company is going to be big enough to need angel or venture capital investment.
I’ve discussed before the conundrum equity crowdfunding presents. In some ways, equity crowdfunding is either an “us vs. them” scenario where you either decide you’re company is right and ready for venture capital funding or that equity crowdfunding is the best fit. Once you head down and are successful with one path, the other bridge is likely not one you’ll be able to pass again.
Life After an Equity Crowdfund Campaign
I spoke with one of the principals at Equitynet a few weeks back and he informed me that the companies on their platform typically only receive five or ten investors in each deal–not the 300+ that true equity crowdfunding is promising. The struggle with crowdfunded companies will be numerous, almost meeting the demands of going public. We expect Title III to wholly increase the demand for companies that need go public in a cost effective way, thus leading to more demand for reverse mergers and public shells.
There are a number of directions a company can go when it comes to using both crowdfunding and reverse merger techniques. The market for the two types of offerings are not mutually exclusive and both can work in tandem to solve the financing and securities needs of mid and microcap companies. I personally foresee many more things occurring on crowdfunding portals that will impact the public markets including PIPE (private investments in public equity) transactions. The JOBS Act’s complete implementation is the elephant in the room for small business finance. It is also important to note that equity crowdfunding and reverse mergers are not mutually exclusive events in business finance. In fact, they represent a greater opportunity to fill in the much needed gaps. In my mind, the two will eventually work together and in tandem swimmingly.
How do you see crowdfunding and reverse mergers working together?
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