Thoughts on Equity Crowdfunding

It's not exactly news that equity crowdfunding has not taken off as expected here in Wisconsin. To-date there have been three registered equity crowdfunding attempts: MobCraft Beer, Common Man Brewing, and Timber Mill. All used CraftFund as their Internet Portal, and none of them met their funding goals.

So why hasn't crowdfunding taken off or been a success? I think it's some combination of three reasons: 1) it's really hard; 2) statutory requirements; 3) demographics.

The first of the reasons is that crowdfunding is really hard. Even assuming everything goes in your favor, the odds are against you. If you look at Kickstarter's statistics you can see that the vast majority of successful projects were actually quite modest: less than $10,000. It would be absurd to do an equity crowdfund for less than $10,000. Projects in excess of $100,000 account for approximately 2.5% of Kickstarter's successful projects, and are less than 1% of all Kickstarter projects. Thus, even on a mature platform like Kickstarter, raising significant amounts of money from "the crowd" is extraordinarily rare.

Second, statutory requirements make raising money via crowdfunding even more difficult. For intrastate raises (which equity crowdfunding must be for now), there are simply far more efficient uses of your time: finding certified/qualified investors. By and large, state securities exemptions these individuals from needing sophisticated disclosures. Thus, rather than pay a lawyer or take the time to create those disclosures (including, potentially audited financial statements), the entrepreneur's time is better spent finding angels, super angels, or other qualified/certified investors. If the entrepreneur tries that route and is unsuccessful, that might be a clue to the fund-ability of the project in general. As many of these investors have said: "Good projects don't have a hard time getting funded. The money is there for the best teams." Of course, for a variety of reasons, some industries aren't exactly trendy, or ripe for angel/super angel investment - for example, lifestyle businesses, and high capital-cost or quasi-manufacturing businesses like food and beverage. It might take $100,000 to $500,000 to get a food and beverage company started, but the returns will be slow and relatively low for a long time, even assuming the entrepreneur has aggressive growth plans (which many do not - but that's another post for another day).

Finally, demographics - especially in the state of Wiscosnin, are against you. Even assuming you have a great project, and it's in one of those hard-to-fund areas like food and beverage, raising "a little bit of money" from "a lot of people" is difficult - we don't have "a lot of people" here. Dane County has a population of roughly 500K, the greater Milwaukee area is, generously, 1.5 million. Let's use the "classic" example of the "local bakery" that needs $100,000 to get started. The local bakery is realistically not going to serve the entire state, it's fundraising is limited to, at most, its city. If that city is La Crosse, for example, that's 50K people. The bakery would need to raise $2 from every single person in the community!! If they get 1% of the community to support them, 500 people, they would need $200 from all 500 people. That is a tough ask; $10 from 500 people maybe, but $200? And that is an extraordinarily optimistic 1% of the community supporting them. And, that isn't to mention whether the legal hassles of DEALING with 500 $200 investors is even worth the money! As I said, your time is probably better spent convincing one or two rich people who can spend $50K each to fund the entire project.

Some Interesting Articles About Entrepreneurship (or, why it's not surprising that Madison isn't on these lists)

There are two new fascinating articles that look at entrepreneurship: Tim Berners Lee's article on Vox.com that highlights how Today's Tech Boom Is Different From the 1990s and another article from Stepanie Walden at Mashable that looks Beyond Silicon at the Top Emerging Startup Markets in the US. Unsurprisingly, it's bad news for Madison and Milwaukee in both articles; somewhat more surprisingly, Chicago doesn't get a nod, either. Indeed, it's more of the same arguing that (Colorado aside) it will continue to be the coasts that are the centers of entrepreneurial activity for the near future.

Read together, both articles highlight the Ouroboros that is entrepreneurial growth in its current formulation in the United States. The bent of Mr. Lee's article is that today's startups are no longer funded by the public; the "public" being defined as "not rich people." Mr. Lee points out that in the 1990s startup activity was funded primarily by the Initial Public Offering ("IPO") which provided a mechanism for "regular people" to support entrepreneurial activity. Of course, entrepreneurial activity is inherently risky. One of the fallouts of the 1990s IPO boom was public wariness of such risky activity. Regular people lost their appetite for supporting yet another failed (internet or pharmaceutical) enterprise. But they also lost the gains that come from "betting" on the right horse, too. If you invested $1000 in Microsoft when they went public in 1986, by 1996 you would have made a 10x return on your money ($100,000)!

IPO activity is (way) down and private equity is scooping up those big returns. By Mr. Lee's math, if you invested in Facebook you will have already doubled your investment, but the most valuable company in the world (Apple) is only a 7x return on Facebook. Of course, this has "de-risked" the IPO market for entrepreneurial startups, but it has also stratified the investment pool. Private equity, venture capital, and super angels - rich people - are seeing the fruits of their investments and sucking up the gains in the growth, leaving mostly matured companies for the public.

The result of this ever-increasing reliance on private money (private equity, venture capital, etc.) is that entrepreneurial activity has become concentrated in the areas where the money is - the coasts. Not surprisingly, Silicon Valley, Boston, and New York top most startup lists. Ms. Walden notes that a full three quarters of all venture capital investment occurs in just three states: California, Massachussets, and New York.

But the interesting note that Ms. Walden makes is that entrepreneurial communities don't just happen, they tend to spring up where established businesses and universities are. By that logic then, it's not surprising that the "hottest" emerging entrepreneurial markets are places that are dense in large(-ish) companies and universities: Colorado, Florida, Texas, Washington, and Oregon.

Given this data and these trends, it's not surprising that Madison and Milwaukee aren't on these lists. While we have a fantastic, world-class University (that our fine state is trying to gut), our share of Fortune 500s is low - we only have 9; Minnesota has 19, Illinois has 31. Interestingly, Oregon and Washington between them only have 11, while Colorado has only 9 as well. However, Colorado has 5 Division I universities tightly packed in the 90 mile corridor between Boulder and Colorado Springs. The same with Oregon and Washington that have multiple Division I schools in a small geographic area. Madison has only 1, while Milwaukee, 80 miles away, has another; the remaining D-I schools in Wisconsin are spread throughout the state.

However, there is reason to be optimistic. While the broader trends point towards continued frustration for Wisconsin, there is better news in niche industries. Wisconsin has a unique opportunity to be a global leader in several, related, niche markets: (value-added) agriculture, (fresh) water, and biotech. These are tremendous areas of focus that fit the natural talents of Wisconsin and the Universities that make up Madison and Milwaukee. We have a density of businesses in these areas and we have a density of students in this areas that few other states can match. As a result, we have an investment community that understands these industries. So, I am optimistic that while Wisconsin will continue to lag in generalized entrepreneurial activity that you can expect greatness in these industry niches.