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Alternative Sources of Financing for Startups Beyond VC, startups have a growing number of options to raise capital
Venture capital isn’t the only option founders have when raising funding for their company. While VC is billed as a gateway to growth, it is not a fit for all companies, business models or founder personalities. It begins an implicit, and sometimes very explicit, need for the company to produce hyper-growth-sized metrics to raise further capital and eventually exit at a huge valuation.
The many alternative sources of capital for entrepreneurs can be broken down into different categories based on the relative size of investment and the amount of support provided to the founder. As a ceiling, VC rounds provide higher amounts of capital, along with a high amount of support relative to these alternative sources.
Crowdfunding began with campaigns on Indiegogo, GoFundMe and other similar sites as a way for companies to showcase their product and raise money for production and development. Investors would get rewards such as receiving the first shipment or discounts depending on their financial commitment. These sites didn’t provide equity in the company, however, and received backlash in 2014 when Facebook bought Oculus for $3.0 billion just two years after the company raised $2.4 million on a Kickstarter campaign. Backers of the crowdfunding campaign were given a final product of the Oculus Rift when it was launched in 2016.
The JOBS Act of 2012 is legislation that passed with the intention of overhauling areas of startup financing. It has had the largest effect on the crowdfunding industry with a provision that helps regulate the sales of equity through crowdfunding campaigns. This sought to offer Main Street investors access to private company securities as well as provide an additional avenue for raising capital to small businesses. Until that piece of legislation went into effect, a company could have only 500 stakeholders before it needed to begin filing public documents with the SEC, essentially becoming a public company without the windfalls of an IPO. The JOBS Act changed the investor amount to 2,000, essentially allowing more people to invest in a private company before public registration. While the law has not had some of the intended consequences, and many of the largest crowdfunding campaigns would still put companies over the investor limit, it certainly has provided a new way for small companies to fundraise. Wefunder, one of the largest equity crowdfunding sites today, has helped nearly 260 companies raise almost $82 million through its crowdfunding site.
There are many limits on equity crowdfunding campaigns.5 For example, companies may not raise more than $1.07 million through crowdfunding in any 12-month period, and all campaigns must take place through SEC-registered intermediaries and file audited financial statements. While unaccredited investors are allowed to participate, there are also restrictions according to each individual’s income. Equity crowdfunding has helped many companies raise capital, and the laws surrounding these campaigns have continued to evolve. JOBS Act 3.0, which would expand access to unaccredited investors, as well as relax other regulatory burdens for companies, was passed by the House of Representatives in 2018, though it has yet to be taken up by the Senate.
Summary of alternative financing types and associated characteristics:
Taken from PitchBook Q1 2020 Analyst Note: Alternative Sources of Financing for Startups