The JOBS Act signed in April of 2012 allows young companies to raise up to $1 million each year through crowdfunding. With its funding cap and risky structure, however, it remains to be seen whether or not the new financing avenue will make any thruway in the clean tech space.
Proof of Concept
Crowdfunding, a financing structure that lets anyone invest small amounts of money in ventures online, began as a mechanism to fund individual projects and products. With the JOBS Act legislation, the financing structure has been expanded to include equity stake in companies. The concept is to aggregate substantial amounts of capital through a large number of small donations.
But for the typically capital-intensive clean energy field, $1 million is change in the pocket. From concept stage to full-out commercialization, the tab can reach into the hundreds of millions for companies in fields such as electric vehicle, solar, and energy generation and distribution.
A niche clean energy initiative that could benefit from crowdfunding is software-based clean energy technology. For Zach Supalla, founder of Evanston-incubated SWITCH, a startup that allows users to control home lighting via the internet and smartphone apps, equity crowdfunding is “a fantastic idea.” Even a few hundred thousand dollars could go a long way in getting SWITCH off the ground and into users’ homes, as the product is built with code and relatively cheap hardware.
Most of the clean energy space can’t be built with code and cheap hardware, however, and the $1 million cap is a hindrance rather than a boon. To get around this, a possibility is to use the $1 million as a stepping stone, suggested Nick Bhargava, CEO at Motaavi.com, an upcoming equity crowdfunding platform based in North Carolina. Companies can use the capital to build a prototype to catch the attention of institutional investors.
“I don’t think crowdfunding is going to replace angels or VCs for high-growth companies,” said Bhargava. “But I do think it provides better access to capital – particularly the early stage capital that a lot of companies have trouble raising simply because they don’t have a lot to pitch.”
Institutional investors may not be so keen on this idea.
“If in that million dollars, a company can demonstrate that they have a very attractive and successful business model, any investor’s going to invest,” explained Wayne Boulais, managing director of Apex Venture Partners, a Chicago-based venture capital firm that funded a number of clean energy startups including Power2Switch, a 2011 Clean Energy Challenge finalist.
“But it’s difficult for a million dollars to actually show that kind of proof.”
Risk and Transparency
Let’s suppose a company clears the hurdle of maxing out its crowdfunded capital, and uses the million to generate an attractive business model. They’ll find that the hurdle race isn’t over yet. For crowdfunding to be viable as early-stage capital for clean tech companies, follow-on institutional funding will need to be at ease with this form of start-up capital. That’s a shaky assumption.
Traditionally, startups raise money from friends and family before turning to VCs and angel investors, who work closely with the entrepreneurs and get to know them personally. One of the major value-adds of institutional funding is the network financiers can leverage on behalf of the startup. Investors often bring on other investors they know well into the venture.
This value-add is lost with crowdfunding, as well as introducing risk for both prospective investors and the entrepreneurs.
“You could be theoretically raising money from lots of people who are total strangers,” said Matthew Brown, of Katten, Muchin and Rosenman, LLP, who works with several tech startups. If you had a hundred early investors, and you subsequently bring on institutional funding, “how are you going to deal with this group of your original investors?”
On the one hand, institutional investors may be uneasy about bedding down with so many early investors, while early investors face the problem of ownership dilution. Entrepreneurs also need to be careful to make sure what power is allotted to the multiple investors when they sign on.
With the low level of investor protection, clean energy crowdfunding is more a debt play instead of an equity play, notes a Bloomberg New Energy Finance report.
Crowdfunding businesses are required by the Securities and Exchange Commission (SEC) to disclose certain information, such as their business model and capital structure. The level of disclosure depends on the size of the investment sought, with audited financial statements required of companies raising over $500,000.
But crowdfunding platforms don’t check the veracity of the statements, only that they are made. There may be a market here for third party services – until then it’s up to the investors to do due diligence. Crowdfunding platforms and investors will most likely depend on the ‘wisdom of the crowd.’ With hundreds of people looking at the same documents, it’s likely one person will pick up something fishy about a statement and create a cascade effect.
The SEC is set to release its regulations at the start of 2013, and hundreds of crowdfunding platforms are already queued up in anticipation. And with that, it remains to be seen whether clean energy businesses will be in on the action.