Crowdfunding is an exciting development that uses the power of the internet to allow entrepreneurs and startups to efficiently raise financing from a large number of people who each contribute a small amount of money. It breaks with the past by enabling companies to locate investors through a passive internet platform rather than through the active selling efforts of a traditional broker-dealer intermediary. Websites like Kickstarter, Indiegogo and GoFundMe helped popularize the concept and led Congress to legalize a variety of new ways for companies to raise capital through sales of stock and other securities.   Regulation Crowdfunding (“Reg CF“) is the latest method to be implemented by the SEC. It went into effect on May 16, 2016 and allows companies to raise a maximum of $1 million in a 12-month period. In its first 100 days, 86 private companies initiated SEC-registered public offerings in this nascent market—including over 40 tech startups.

We examined this first group to obtain preliminary insights into the trends that may shape this market.

What kinds of companies are using Reg CF?

So far, Reg CF has been most popular with young and small companies. Of the 86 companies in our data set, sixty-two were organized within five years (72%) and 32 within one year (37%), almost 70% of which were organized as corporations. Sixty-one reported one to five employees (71%). The largest example reported only 28 employees. Although Delaware was the most popular jurisdiction of organization, California was the most popular principal place of business with 29 companies (34%), followed by New York (8), Florida (7), and Texas (4).

Although a variety of industries are represented, the majority of companies (44) are technology companies. This includes companies focused on biotech, cleantech, fiber-optics, virtual reality, online marketplaces, social networks, mobile platforms, and apps.

What is the success rate for Reg CF companies as of October 10, 2016?

Out of the 33 companies whose respective funding deadlines had passed as of October 10, 2016, 14 successfully funded their campaigns, raising approximately $6 million, including three companies that each reached the $1 million maximum. Four failed to reach their targets and 15 did not publicly disclose their results. The average capital raised was approximately $400,000, and the median was approximately $266,000. Out of the 53 companies that had not yet reached their offering deadlines as of October 10, 2016, 15 had already met their capital-raising goals, while 28 were still working toward their targets and 10 had not publicly disclosed results.

Have Reg CF companies raised capital before?

Forty-two companies in our data set (~49%) reported prior capital-raising, including through bank loans, private placements of securities, grants, and rewards-based crowdfunding (e.g., Kickstarter), while 24 reported no other capital-raising in the prior three years and the balance did not disclose their prior capital-raising efforts. Notably, the majority of successful examples as of October 10, 2016 raised prior capital from accredited, or otherwise sophisticated, investors, and then used Reg CF as a supplemental follow-on way to raise financing.

Why are these types of companies choosing Reg CF?

There are a few common themes as to why companies are choosing Reg CF. For some, it is to allow persons in communities with special knowledge and interest about a product to participate early in its success. For example, a biotech company developing a bionic pancreas stated that it wants “to keep this within the Type 1 Diabetes community”. Another company, which uses bio-engineering to create home goods (such as a glowing plant), stated it is using Reg CF to democratize its investor base and build a community to evangelize its product. Other companies have echoed similar themes and also stated that they are laying the groundwork for future offerings.

Conclusion

Reg CF seems to be most attractive for companies that present a consumer-directed product with a compelling story that is both easy to understand and energizing to founders and investors as they seek to build a community around new products or services. However, it is not clear that Reg CF should be recommended as an initial means of raising capital. Many of the companies in our data set raised earlier rounds of capital through more conventional financing routes involving sophisticated investors, before seeking supplemental capital through crowdfunding. If this trend continues, it may have important implications for when crowdfunding is appropriate in a company’s life-cycle. In any event, we expect Reg CF to continue to generate interest as an attractive option in the technology sector.

This post comes to us from Anand Saha and Jason W. Parsont of Clifford Chance US LLP in New York, where Mr. Saha is a partner and Mr. Parsont is a senior associate. Mr. Parsont is also the founding editor-at-large of the Blue Sky Blog and the author of Crowdfunding: The Real and the Illusory Exemption, 4 Harv. Bus. L. Rev. 281 (2014) available here. This post was originally published on February 28, 2017, on Clifford Chance’s Talking Tech website, available here. The authors would like to thank Christine Kim and Sophie Hasse of Clifford Chance for their research assistance and for compiling the authors’ data set.