Deal to Watch: A Major Player in Crowdfunding

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Summary

The StartEngine Crowdfunding Inc. team has been selected as a “Deal to Watch” by KingsCrowd. This distinction is reserved for deals selected into the top 10%-20% of our due diligence funnel. If you have questions regarding our deal diligence and selection methodology, please reach out to hello@kingscrowd.com.

Problem

Venture funding is a lifeblood for early-stage companies. Without it, the job-creation engine that has made the US the global center for startups would slow to a crawl. Even in the US, venture funding is not evenly-spread. In 2019 alone, 74.4% of all funding flowed to two of the country’s eight regions: the West Coast and Mid-Atlantic. This concentration has created hotbeds of startup and growth opportunity while other parts of the nation starve. The Mid-West, for example, is the most impoverished part of the nation, with only 0.6% of VC funding flowing to it last year. Add to this the other problem that investing in private deals (where return prospects can be higher than in public markets) is typically reserved for the wealthy, and you have most investors spread across the country locked out of these transactions.

Solution

One company looking to address these challenges is StartEngine Crowdfunding Inc. In its simplest form, the business is a web-based portal where people can look at crowdfunding deals. Users are able to invest in these firms through private fundraises, usually organized under Regulations CF, A+, D, or 506(c). Investment minimums vary based on the preferences of the company. The structure of the deal can also vary a lot as well. Options range from common or preferred stock to revenue-sharing and profit-sharing arrangements. Convertible notes and SAFEs are also common instruments.

StartEngine has a number of ways it can generate revenue. The primary focus of the business is in charging a percentage fee on capital raised through its portal. As part of these raises, StartEngine also occasionally takes an equity stake in the firms on its portal. They also provide a range of services for the firms in question, including marketing and advertising.

Since its launch in 2015, StartEngine has seen tremendous success. Over $125 million has been raised on their platform. This amount is spread across more than 325 companies in 64 industries and in 306 counties throughout the US. Over 80,000 investors have participated in their deals with an average investment exceeding $1,500. According to management, 51% of the companies that raise money on the platform come back to raise subsequent funds. The total amount invested through the platform has grown rapidly over time. In 2019 alone, the company saw $43.72 million invested in companies through its platform. This amount represents an increase of 67% year-over-year.

By 2029, management hopes to have raised over $10 billion for startups. But continuing on with this path of acting as a fundraising site is not the business’s only ambition. StartEngine also envisions becoming an exchange of sorts for the crowdraising industry. It is working on receiving approval from FINRA and the SEC to launch an ATS (Alternative Trading System). Through such a system, it would enable users to trade private securities just like they can with publicly-traded companies. This change will add liquidity to an otherwise illiquid market and open a new opportunity for investors and equity analysts alike.

Even though StartEngine’s transaction growth surged in 2019 compared to 2018, the company’s financial situation was mixed. In 2018, the business’s revenue totaled $4.68 million. This dropped 7.7% to $4.32 million in 2019. At first glance, this is scary and it may even imply fee compression. That would be a sign of competitive pricing in the industry and would be a harbinger of bad news. Fortunately, the picture is not that bad for the company.

As StartEngine grows, management is not afraid to change their product mix around. Compared to the 2018 fiscal year, 2019 saw two big revenue categories report declines year over year. One of these was StartEngine Premium, which serves as the company’s marketing services offering. In 2018, revenue from there totaled nearly $1.50 million. This dropped to $622,654 in 2019 as the firm moves away from their Premium offering and toward other similar features like StartEngine Promote. The other big decline came from events, sponsorships, and licensing, with sales dropping from $671,687 to $11,000. Management made the conscious decision to discontinue their large investor summits. It is uncertain why this decision was made, but it could be due to the costs associated with those events. If you look at the company’s core business, Regulation CF capital raises, the picture is actually getting a lot better. From 2018 to 2019, sales here jumped 83.4% from $1.41 million to $2.59 million. That’s a great sign to see.

This change in offering mix does seem to be helping StartEngine’s bottom line to some degree. Its net loss of $4.01 million in 2019 was marginally better than its loss of $4.60 million a year earlier. Its operating cash flow, meanwhile, reported a significant improvement. In 2018, this figure was -$4.44 million. It narrowed considerably to -$2.76 million last year. This did, however, come at a rather high cost. As accrued liabilities rose, the firm’s current liabilities and total liabilities grew by $831,684.

Financial condition aside, StartEngine has definitely succeeded in its goal of opening investing to the masses.  While overall VC data is difficult to come by, the company has kept track of Regulation CF funding figures by state since mid-2017.  In its first report, covering the period of May 2016 to May 2017, the companies said that businesses coming from just the top three states accounted for 69% of all Regulation CF capital raised.  By the first quarter of 2020, the top 10 states accounted for only 60.9% of funding.

An Attractive Market

The industry that StartEngine is in is fairly small these days, but it’s growing at a nice clip. According to one source, total global transaction volume in the space will be $8.54 billion this year. This figure is up 23.3% compared to 2019. By 2023, the crowdraising space is expected to grow to nearly $12 billion, implying an annualized growth rate of 12%. Another source entirely pegs the market at $13.73 billion today. It believes the market should grow by 16% per year, eventually hitting $28.8 billion by 2025.

Irrespective of how large the industry actually is, there’s no disputing the fact that StartEngine is one of the big players in the space. One source pegged StartEngine as the second-largest crowdraising platform in the US last year. In all, it accounted for 27.1% of the industry’s transaction volume during the year when discussing only Regulation CF opportunities. That 27.1% comes out to $28.59 million in raises. Only Wefunder was larger, with a market share of 31.1% representing $32.87 million in transaction volume. Republic came in third at just 19%.

According to Crowdwise, the industry in the US saw 735 crowdfunding raises in 2019. This number was down from 763 a year earlier. In all, StartEngine accounted for 20.8% of these, or roughly 153 transactions. Wefunder, once again, was in the lead. For the year, it accounted for 21.8% of the market. In third place, was Republic at only 9.7% of the industry’s market. All of this combined makes StartEngine a formidable player in this industry. Admittedly, the market is still small here. In 2019, all Regulation CF and some Regulation A+ and 506(c) transaction values combined totaled $339.4 million. Those raises were split between 432,487 backers across 2,187 campaigns. Proceeds went on to support an estimated 11,264 jobs. That same source believes that these capital raises in the US will only continue to grow. By next year, the expectation is for transaction volumes to hit $500 million or more.

One great thing about crowdfunding is that it opens the door to significant diversity. When people think about startups, most probably think of tech firms. Certainly, they are a big part of the ecosystem. In 2019 in the US, application software firms were the companies that received the greatest amount of crowd-raised funds at $43.8 million. In second place, though, were beverage firms. These saw funding worth $30.8 million. In third place, by a hair, were entertainment companies. This disparity shows that crowdraising is a one-size fits all opportunity for early-stage firms.

Terms of the Deal

In order to continue growing, the management team at StartEngine is raising additional funds through a common stock offering. The goal is to raise as much as $370,000, but the firm will accept as little as $10,000 in all. Shares are priced at $11.25 apiece. To participate in the transaction, the company is requiring a minimum investment per participant of $506.25. Despite the company’s high pre-money valuation of $190 million, they have so far received commitments totaling $90,843.  

In addition to this Regulation CF raise, the business is also raising money under a Regulation A+ where it is slated to receive proceeds of up to $41 million.  This separate raise will consist of proceeds of no more than $40 million from common shares priced at the same $11.25 as their public crowdfund raise and $1 million associated with preferred units.  The preferred holders will be entitled to liquidation preference over the common holders.

An Eye on Management

The top brass in charge of StartEngine truly is impressive. At the helm of the company is Howard Marks. Marks is the company’s CEO and its Director. He is also one of the company’s co-founders. Before starting this company, he founded a startup accelerator also called StartEngine in 2011. At one point in time, he was also the founder and CEO of Acclaim Games, a video game publisher now owned by Disney. But his big claim to fame was his early role as the Chairman and head of Activision, a company now valued at $56 billion.

Another key figure at StartEngine is its other co-founder and its current Executive Director, Ron Miller. He has also founded and ran, as CEO, Disability Group Inc. Prior to that and prior to his work with StartEngine, Miller had five previous startups, all of which he built up and sold for undisclosed sums. The last key member is Johanna Cronin. Cronin currently serves as StartEngine’s CMO. Her prior role was as an SEM analyst for Dex Media Inc. She was, besides the co-founders, the first employee to work for StartEngine.

Rating

StartEngine has been rated by our team as a “Deal to Watch”. The company exhibits significant opportunities. This is, of course, if you only account for lines of business they are not moving away from. This is especially true of revenue tied to transaction volumes. Robust year-over-year expansion on this front is an excellent thing for investors to focus on. The industry the company plays in is fairly small, but it’s growing at a nice rate. Add to this its status as a leader in this space and it’s clear the company has a lot going for it. Another impressive element of this picture is the qualified management team in charge of the business. Having a strong team that includes two well-tested co-founders is a great advantage as well.

This is not to say that everything regarding StartEngine is great. There are some issues. While the company’s net loss and operating cash outflows improved quite a bit between 2018 and 2019, the firm is still very much in the red. This simply cannot last. Eventually, the business needs to turn a profit and until it does investors will see some dilution. The other problem is that while the growth rate of the business is high, and it is a market leader, the valuation looks awfully high. This is especially true for a company with such little revenue and high losses/outflows. Even with those issues, though, the firm does seem to make for an attractive prospect given the market trends at play.