Traditional versus New Models of Capital Raising
Private capital raising has typically hinged on companies and funds being able to connect to a narrow base of large institutional investors. This historical focus on only tapping a select group of large investors is largely a byproduct of a regulatory and technological framework in which the costs—whether in time, money, or compliance risk—of accessing more investors outweighs the benefit of receiving more numerous smaller checks. New innovation and new regulation are changing this paradigm. [See ‘Fundraising Post JOBS Act‘ for more] As this space evolves, I believe the new “normal” in private capital raising will include substantial funds being raised by a larger pool of smaller investors that have been aggregated via low-cost and scalable technology solutions.
The Old System of Raising Capital
Imagine the traditional structure of the historical private capital landscape as one giant see-saw with investors forming the base of the seesaw and the companies and funds seeking capital as the board on top. The ultimate goal is to get as many investors exposed to as many capital raisers as possible in order to foster the most efficient transfers between buyers and sellers. This is basically the definition of an efficient free market (one with open information and friction-less transactions to satisfy supply & demand).
Areas of Inefficiency in the Old Capital Raising System
Clearly, however, a see-saw represents a system in a delicate and often sub-optimal balance. The companies in the middle of the see-saw (Company A), can easily access the select venture capitalists, private funds, and well-known investors that form the top of the see-saw’s base. The smaller yet more numerous investors underneath this upper strata have less exposure to these opportunities, even if they are still writing checks worth millions of dollars. The problem is even worse for companies however. Outside of that narrow subset of companies in the middle, as you move along the see-saw (towards either ‘Company X’ or ‘Company Z’) you start encountering companies and ideas for which raising capital has historically been much more difficult, time-consuming, expensive, or downright impossible. This caps the number of good ideas and good companies that have access to capital in order to grow. As a result, private capital raising has existed in a distinctly sub-optimal way. [See ‘Strategies For Businesses Seeking Capital‘ for more]. It has provided outsized rewards for a select few while throwing up unnecessary barriers to the efficiency of the system in general. [See this post for more on this returns argument]
Online Platforms: A New Approach
In part this explains the parabolic rise in the popularity of crowdfunding platforms. If we go back to the see-saw analogy it is easy to see that underneath this narrow layer of investors that have historically had access to this market is a much more diverse landscape of capital providers that is ready to participate in funding new innovative ideas, new companies, and up-and-coming funds. Indeed, this is already happening. The potential advantages for all parties is fairly straightforward and has been outlined in detail elsewhere: more contact points, more interested investors, more investment opportunities, and more ideas funded at better terms. To the extent to which technology solutions can optimize the functioning of a this traditionally opaque marketplace the resultant structure for the private capital markets would be a more stable, efficient, and level playing field.
Integrating Old and New Systems for Capital Raising
This is not to say there are not advantages for a company in limiting the number of its investors. Aside from the simplicity of large block investments versus more numerous smaller tickets, there are advantages for companies in ensuring that at least some of their investors are of strategic value. Furthermore, having an order of magnitude more investors inherently complicates future communication efforts as well as adding incremental costs. As a result, a primary and still unaddressed challenge within private capital raising is merging the desire for democratized access and more involvement of retail accredited investors with the assurances of institutional level due-diligence and the benefits of having large ticket connected investors supporting private company growth.
In short, the challenge ACE seeks to address is the integration of institutions and individuals into one coherent streamlined process that benefits all parties involved by lowering risk, ensuring fair and transparent information disclosures, and highlighting the benefits of professional vetting and communication of the opportunities and risks.