Thursday, August 20, 2015

Measuring the Crowdfunding Impact on Traditional Investment Banking, Including Mergers and Acquisitions

Today's guest post on Crowdfunding comes from Nate Nead, a Director at

Measuring the Crowdfunding Impact on Traditional Investment Banking, 
Including Mergers and Acquisitions

The rise of crowdfunding has been greatly promulgated by sites like Kickstarter and Indiegogo. In what is being dubbed as the true “democratization of capital” companies with little to no financial resources can pitch an idea to receive small amounts of funding from large swaths of potential “backers.” This new form of non-dilutive financing has been working well for years now. Its sister, equity crowdfunding, is plodding along through regulatory hurdles with some success. This summer’s release of Reg A+ (an update of the long-standing Reg A regulation that expanded the offering amount from $5M to $50M) underscores the fact that regulators have not been completely closed to the idea that true crowdfunding for equity may eventually become a reality. As equity crowdfunding grows from adolescence to full maturity, casualties are sure to follow, including those in traditional finance and investment banking. Once efficient, this new form of capital formation is likely to impact everything from traditional capital raising methods to mergers and acquisitions.

Growth Capital & Alternative Finance

Alternative finance is more than just crowdfunding. The rise of many non-bank lenders over the last several years has proven an effective competitor to some of the largest banking institutions. As regulators and internal controllers have tightened the belt on lending standards for small businesses, others have swooped-in to help fill the void. In some cases, the alternatives have not played well as a good replacement for the more regulated traditional banks, but that doesn’t mean they’re not helping to fill the demand void in the market.

Just as non-bank debt financiers are currently providing a new source of competition for retail and merchant banking, it’s expected a similar phenomenon will follow investment banking with the rise of equity crowdfunding.

As equity crowdfunding becomes more efficient, the cost of capital requisition is likely to decrease over time. Unfortunately, many prognosticators aren’t expecting all the capital efficiency gains to be passed to entrepreneurs in the form of lower fees. While this may be the case in some instances, the greatest advance is likely to be 1) the speed with which capital can be garnered and 2) the confidence in the process. Currently, many “best efforts” offering promoted by investment bankers still go unfulfilled, despite best efforts. The lack of efficient scale can still leave many would-be-successful entrepreneurs empty handed, regardless of the quality of their team and business plan. The increase in the probability and confidence that a full subscription can and will occur further feeds the speed component of getting a deal consummated. While, in the end, the actual paper cost of capital may remain unchanged, the time and confidence factors should fuel the potential for more deals and better deals.

Company Sales & Mergers and Acquisitions

When it comes to crowdfunding, alternative finance and venture capital, the sexy, scalable growth companies get most of the press. This hogging of the limelight may get people excited, but the reality is there are more opportunities to tap existing and profitable companies than there are to seek after pie-in-the-sky growth. The sheer size difference between venture capital and private equity illustrates the point: private equity could be greatly upended by a shift in the process and equity crowdfunding could play a role.

Traditional private equity seeks to raise capital, perform a buyout (LBO or otherwise) and take the platform company on a path toward growth. This path could include organic synergies or a strategic buy-side M&A/roll-up scenario. In almost all cases, there is an extreme focus on eaking out waste and maximizing IRR for fund investors. But how could the crowd upend this deeply-entrenched segment of alternative finance. Here are a few potential ways:

      Family-owned businesses may opt for next generation transition without the need for controlling outside capital or expensive and often harming Employee Stock Ownership Plans. An equity crowdfunding event could help in the sale of the majority of the shares while still keeping control in the original family.
      Companies looking to maintain full control of both the board and the shares could vye to sell shares for “taking chips off the table” or for growth capital with an equity crowdfund campaign.
      Equity crowdfunding may provide capital for the equity funds themselves, allowing them to further growth initiatives and differentiate on a platform company that has massive room for growth.
      If a business owner wished to sell-out over say a five to ten year horizon, s/he could sell the company off in chunks (say $1M/year) for several years to various investors via a 506(c) offering.

Because a full ¼ of those currently in the workforce will be retiring in the next 15 years, many will be seeking solutions for selling-out prior to retirement. At some point, I would expect a typical sell-side mandate or even an ESOP could be replaced by some creatively-structured equity crowdfunding deal, perhaps even a well-crafted intrastate offering. The creative options for using equity crowdfunding abound and disruption is ultimately inevitable.

Some may claim technological advances in the realm of crowdfunding and other forms of alternative finance are having a deleterious impact on traditional channels for capital advisory. This “upending” may eventually be blamed for net job reduction and ultimately another example of Creative Destruction. As the maturation occurs, other positives are also certain to emerge, however. First, the efficiency of the process may help improve the overall view in what has recently been painted as an industry of money hungry criminals. Second, those working in the capital markets will require greater understanding and more sophistication as it relates to the available tools and options. This will be most important as investment bankers look to act as guides for investors and entrepreneurs along the path from growth to exit.

Nate Nead is a Director at Nate’s roll involves traditional buy and sell-side mergers and acquisitions advisory, investment banking, capital raising and general capital advisory services. Nate specific focus is software and SaaS investment banking where he works with growing middle-market software companies looking for growth capital, buy-side acquisition assistance or sell-side advisory services. Nate resides in Seattle, Washington with his wife and two children.

No comments:

Post a Comment