Bill Clark is the CEO of Microventures, a securities broker/dealer that uses a process similar to crowdfunding which allows backers to invest $1,000 to $30,000 in startups online. You can follow him on Twitter @microventures.
President Barack Obama is expected to sign the JOBS Act today, officially opening up a new source of funding for small companies and startups. Much of the attention so far has been on this component of the bill because it would allow financing via crowdfunding. Participants can raise as much as $1 million a year without having to do a public offering — a step requiring state-by-state registrations that can cost thousands of dollars.
The belief — and hope — is that this type of funding will open up more opportunities for capital to flow into startups. That, in turn, will help grow new companies and create new jobs.
The reality is that crowdfunding may not be right for every startup. Some business models are more capital intensive and wouldn’t fit within the constraints of crowdfunding. There are several factors to consider before pursuing this type of funding. Let’s take a look at what they are, and what this new piece of legislation might mean for your next fundraising round.
1. Consider Prior Raises
If you have raised money previously and that total is more than a $1 million in the last 12 months, then you will not qualify for the crowdfunding exemption. If you can wait until the 12 months are up, then you should be OK to use the exemption in the future.
2. Have a Communication Plan
Have you thought about how you would communicate with potentially a 1,000 or more investors brought in through a round of crowdfunding? You may not have enough time in the day to address all their questions or concerns. The last thing you want is for this to take valuable time away from running your startup or business. If you use a funding portal, that company should help you manage your communication with your investors. Companies like Caplinked also provide tools that a startup can utilize to message with all of its investors at the same time.
3. Keep Your Secret Sauce In Check
Some companies don’t want to share a business plan or idea unless those involved sign a non-disclosure agreement. The fear is that a competitor will get their hands on it. If you put your business plan on a funding portal that anyone can look at, then this could be a problem. You do, however, need to give potential investors enough information to make a good decision, so here are the items you need to provide so that investors can still do their due diligence: company name, address, bios of the officers and Board of Directors, a business plan and description of the business, and how you intend to use the funds raised.
4. Show Them the Money
If you don’t want your competitors to see how much volume you are doing or how you make money, then you probably don’t want your financials out in public. (This is one of the reasons that Facebook waited to do its IPO.) But if you crowdfund, you may need to provide different amounts of financial information to your investors depending on the amount you raise. Here’s the breakdown:
- Less than $100K: You are required to provide your income tax returns and have your financial statements certified by your CEO.
- $100K to $499K: Your financial statements will need to be reviewed by a public accountant.
- $500K to $1 Million: You will need to provide the investors with audited financials.
5. Lawyer Up
The investments you receive through crowdfunding will be for equity in your company, so you will need to have a lawyer structure the deal and set up the necessary funding documents. It would be ideal to have a Private Placement Memo that would disclose all of the risks to an investor. The legal documents can get pretty expensive. At the low end I would estimate you might pay $7,000 for a business that is not very complex. The costs just go up from there.
6. Look at Front Costs
There are a lot of costs that you will have to pay before you even put your opportunity online for people to invest in. Between audited financials, legal fees, and paying to hold your money in escrow, you could spend $10,000 to $15,000 before you raise your first dollar. If you are only raising a small amount, the cost might not be worth it. Or, if you’re a startup, you might not have the funds to set up crowdfunding.
7. Have a Plan B
Because the SEC has 270 days to implement the regulation, startups will not be able to use the crowdfunding exemption until early 2013. In the meantime, there are a few other options startups should consider. They can raise what are essentially loans from sites like Prosper.com or LendingClub. Or, they can get a peer-to-peer loan to test out, so they can see if crowdfunding would be right for them. AngelList is a good service to list your startup on, and it will make your company visible to active investors.