The SEC and New Breed of Startups Fuel the Equity Crowdfunding Flame

For Gumroad’s Sahil Lavingia money didn’t always come easily. But in recent months, not only did his digital-goods business book a profit for the first time, it also signed more than 7,000 non-accredited investors–many of who are Gumroad customers–in less than 24 hours.

“I think if we can start to see more startups raise money from their customers, from their communities, from the average person, or non-accredited investors… I just think that’s good for the world,” says Lavingia, who is the founder and CEO of the 10-year-old company. 

Gumroad is just one of many startups capitalizing on a recent rule change from the Securities and Exchange Commission, which expands the amount so-called non-accredited investors–those who may not have income or asset thresholds required to be considered “accredited”–may invest in private companies by way of equity crowdfunding. As part of the 2012 Jobs Act, the SEC on March 15 raised the cap individual private companies may fetch from crowdfund investors to $5 million, up from $1.07 million. 

Great Expectations

Before he could lasso all those investors, however, Lavingia had to first fix his company, a journey he recounted in a blog post from February 2019. From inception, Gumroad seemed fated to take off. In 2011, Lavingia had launched the company after parlaying his early success at Pinterest–he’s the company’s second-ever hire–into a $1.1 million seed round. Gumroad, at the time was based in San Francisco, and landed some key investors including Mike Abbott from Kleiner Perkins Caufield & Byers (KPCB).

Eventually, the company floundered under the weight of its great expectations. In 2015, everything came to a head. While it had a strong community of artists, writers, and other creators who relied on the service to sell their intangible goods and services, Gumroad just wasn’t growing fast enough. In November, after Gumroad failed to raise a Series B, Lavingia had to lay off 75 percent of the company; cutting a team of 20 people to a team of five. After a short while, he packed up and left San Francisco. 

Instead of selling the company, as many founders do in similar straights, Lavignia focused all of Gumroad’s resources on starting a premium service. In 2017, Abbott, its lead investor, had offered to sell back ownership of the company for $1. Other investors soon followed. 

Then, in 2020, the tide turned. The nascent creator economy, which had been growing by the year, got a boost from the pandemic, as millions of young people suddenly without job or school prospects turned to the internet to make money. Gumroad had its best year in 2020, generating approximately $9.2 million of revenue and more than $1 million in profit. Last August, Lavingia partnered with AngelList and launched a $5 million rolling fund for early-stage startups. 

Rewards and Risks

What changed? The world caught up. “I think it’s a long trend in the same direction, in which creators are continuing to build audiences and go direct to consumers. And every sort of generation, every sort of cohort, is getting betting at doing that,” says Lavingia. 

Take being a musician. Most new artists start building a social media following right away, which continues to grow throughout their careers. “So when you have an album, you already have an audience to share it with,” he says. 

That’s also true in the investor space, which Lavingia says is poised to be a boon for startups. The vast potential of equity crowdfunding created by the Jobs Act is only now really beginning to take shape. Other startups that have joined the equity crowdfunding bandwagon include blockchain construction company Digibuild, livestreaming app Clash TV, and ParkNav, an app that locates free parking spots. 

For its part, Gumroad hit the enhanced limit within hours. The startup raised a total of $5 million from more than 7,000 non-accredited investors. Anyone with as little as $100 was able to buy a stake in the company. 

The diversity of stakeholders has inherent benefits for founder-led companies. By letting thousands of non-traditional investors own equity, rather than a smaller group of professional investors, you’re not only broadening everyone’s risk, you’re bringing more people to the table. “It doesn’t matter how diverse you are, if you’re raising from 400 people.”

By contrast if you limit your outreach, you’re limiting your own potential. “It’s like saying ‘I’m only hiring people who live on this one-block radius,’” Lavingia says. 

But equity crowdfunding has its drawbacks, for both investors and startups. The $5 million cap means that companies in later stages will still need to rely on more traditional sources of funding. Also, startups will need both a large customer base and enough momentum for crowdfunding campaigns to be successful. Equity crowdfunding platforms like Republic are “all-or-nothing,” meaning if the amount your startup raises falls short of its funding goal, all the money is refunded to investors. 

There are also substantial risks for investors. Unlike investing in publicly-traded stocks, investors will have to find an interested private buyer to unload a crowdfunded investment. As Republic notes on its site, there’s no guarantee that a buyer will be interested in purchasing your securities. What’s more, the ability to sell is restricted for the first year, which means even when crowdfund investors do find a private buyer, they might need to hold off selling. Equity crowdfunded startups also have a high failure rate; only 50 percent of crowdfunding campaigns are successful. Not to mention that 90 percent of startups fail. All that being said, the new SEC rule may alter this dismal failure rate by giving startups a whole new avenue to raise capital. 

Amateur investors might also miss the signs of a bad startup idea or they may unwittingly fall in with a low-quality venture, says Gale Wilkinson of Vitalize Venture Group. She notes the promise of equity crowdfunding for startups but also recommends caution. “Adverse selection is a concern that a lot in the venture world have,” she tells Inc. “If a founder can’t raise via traditional VCs, which to date has been seen as the gold standard, then they might try crowdfunding as a second option.”

Lavignia thinks he can buck the downsides. After all, there are just as many–if not more–negatives associated with working with venture capitalists. Many of Gumroad’s investors now include creators who use the platform to sell their services. Lavignia believes that this aligns with a long trend of creators building audiences on social media and going directly to consumers, without the help of traditional gatekeepers. 

“Founders now are creators too, right? Founders are building their audiences on the internet and able to do this,” says Laviginia.