When the JOBS Act (“Jumpstart Our Business Startups”) was signed back in 2012, the intent was to make access to capital easier and less restrictive for small businesses. This was one of the few bipartisan pieces of legislation passed by Congress and has had broad support for a number of years.
Under Title III of the JOBS Act, also referred to as the Crowdfund Act, small companies could issue securities (sell equity / shares) to the public in ways that were not previously permitted. The hope was that average Americans would be able to invest small amounts of capital in small business ventures through a web based platform without the cost and complexity associated with public securities exchanges. Hundreds or thousands of small investments would be pooled together to give the business the working capital it needed. The “crowd” makes it possible for good ideas and concepts to get launched, even when the business or concept doesn’t appeal to conventional investors and banks. Now small business opportunities were open to thousands of non-accredited investors and potentially millions of individuals seeking investment opportunities.
A number of Crowdfunding platforms were launched, developing creative ways of raising capital. But, not all of these platforms are created equal and each offers different financial options for both the business and the investor. Some offer campaigns to solicit donations in return for rewards or discounted goods and services, while others seek investors to purchase equity in the company or provide various forms of debt financing.
The most popular method of crowdfunding is referred to as “Reward Based” Crowdfunding, which solicits donations in return for incentives or rewards that the sponsor (or small business) provides. The leaders in this arena are Kickstarter.com and Indigogo.com. The business seeking money launches a campaign that has a stated goal for their capital raise. Typically, the reward is a discounted product or service of the business that is offered for redemption in the future in return for providing capital today. Let’s say you are publishing a book that, when finished, will retail for $25.00. As part of your capital raising campaign, you offer donors to your campaign the same book for $20.00. The hope is that the discount will be attractive enough to gain hundreds of donors. This method of fundraising has been done for years in places like PBS. Many entrepreneurs consider this to be “cheap money” because they are raising capital without selling off an equity stake in their company, or incurring debt that needs to be repaid.
In reality, this type of crowdfunding is not dissimilar to alternative finance options that factor your receivables, such as merchant cash advances or revenue based finance. These companies purchase future receivables at a discount by providing working capital immediately against sales you will make in the future. They may give the applicant $100,000 today for $125,000 worth of future sales over the following year. The same principal is at work here that occurs with rewards crowdfunding – just without the work of creating marketing campaigns to enlist donors and the uncertainty that can come along with “all or nothing” crowdfunding.
The second group of crowdfunding platforms provides you with working capital in exchange for a piece of your company’s equity. This is really an abbreviated micro public offering of your company’s stock. One of the biggest benefits of equity crowdfunding is access to larger funding amounts of $500,000 and more. While equity financing seems attractive to many business owners because it technically does not need to be repaid, it does come with many other costs and considerations. First and foremost, is that you will be bringing on new partners with all the benefits and headaches that this entails. The downside is that you now have many partners and you have a new level of transparency and reporting that you didn’t have before. Managing numerous investors can become time consuming. Even if the crowdfunding site combines the investor “crowd” into a single pool, you are still required to report results according to SEC requirements.
The most recent draft of SEC regulations requires founders to have their financials reviewed or formally audited by a CPA. Additionally, companies are legally required to publicize a detailed business plan, a list of all large shareholders in the company, a description of the financial condition of the company, as well as file an annual report with the SEC. This is no small undertaking and many smaller business owners consider other options, particularly when raising smaller amounts of capital.
Equity crowdfunding platforms operate in different ways. Companies like CircleUp, act as intermediaries between investors and companies looking for funds. They typically hold investors’ funds in escrow until the round ends successfully, then transfer equity to the company and complete the transaction. Some platforms like Crowdfunder.com and Fundable.com are basically publicizing the individual fundraising campaigns to the investor public and do not act as an intermediary in the transaction. The company seeking funding contacts the individual investors and collect funds and deliver stock certificates on their own.
Check with various sites to see if they have had any successful placements with businesses in your sector. Not all platforms are suitable for various business types. CircleUp and LocalStake perform well with consumer products, food & beverage, apparel, fitness and supporting technology. While EquityNet and AngelList focus on higher tech, B2B and IT driven businesses.
Outwardly, crowdfunding looks like a simple process, but the reality is that it takes work and time for the company to create a compelling campaign and oft times produce the documentation necessary for a successful capital raise. This is particularly true if you are seeking equity or traditional debt financing. The obvious advantages include access to interested investors who regularly follow these sites as opposed to identifying and soliciting investments from individuals you may get introduced to. This is the scalability of technology, but it also puts pressure on you to produce a story that will get an investor to write a check.
Even if your campaign is well crafted and up there on a popular platform, it will be up to you to drive interest through social media and your own savvy. Many crowdfunding campaigns are heavily funded by people you already know and in fact some sites actively push you towards your family and friends to seed the round. Frankly, if that’s the case there is really no reason for you to channel their investment through the Crowdfunding platform as they will charge you a fee for money they had no influence in raising.
The other factor is time. These campaigns can consume a considerable amount of your time and attention and may result in an unfunded capital raise because you failed to hit your target (all or nothing financing). You have your ideas and strategy out there for the public to see and scrutinize and while most agree the risk of someone copying your newest creative, disruptive idea is small – it can happen.
All things to consider before putting everything up on the web.