(As appeared in Forbes.)
Some entrepreneurs wonder if they should bypass traditional investors and go with crowdfunding, based on the assumption that it’s easier to raise money that way. While it’s true that some successful startups sowed their very prolific seeds through crowdfunding—eventually attracting larger VC money—it may not be the panacea you think it is.
Equity crowdfunding is getting even more interest now that the Securities and Exchange Commission (SEC) has passed Regulation A+ updates. This regulation is a part of Title IV of the Jumpstart Our Business Startups (JOBS) Act. Reg A+ gives entrepreneurs new avenues for raising capital by allowing them to advertise funding campaigns to accredited and non-accredited investors, with funding caps. And many people are anticipating the SEC to approve Title III of the Act sometime later in 2015, which is more of a ‘retail crowdfunding’ approach. If Title III is passed, entrepreneurs expect that anyone from Aunt Mary to Mark Cuban will be able to participate in equity crowdfunding, regardless of accreditation status or income.
Regardless of how the above regulations evolve, as in anything with entrepreneurs and raising capital, your strategy depends on your objectives. Here are some perceptions, challenges and considerations regarding crowdfunding:
Crowdfunding: marketing hype or funding channel? Up until now crowdfunding could be considered as much a marketing tool as an investment mechanism—increasing exposure to potential investors and customers. Some well-capitalized companies have used crowdfunding sites for that exact goal: to get eyeballs. Look, if you need capital get an investor. If you need visibility, get a marketing firm. Intermingling the two can be more trouble than it’s worth.
SEC compliance can be mind numbing. Equity crowdfunding comes with regulatory responsibilities that may be too much for you to take on. To the SEC, equity crowdfunding is the same as selling securities, and thus requires mechanisms to protect investors. For instance, under Reg A+ rules, you must file an offering statement with the SEC. This disclosure can be expensive to produce, especially for a business in need of capital. And, Reg A+ funding requires ongoing SEC reporting and issuers (that’s you) are subject to FINRA (Financial Industry Regulatory Authority) review as well. Sound involved and unpleasant? It may be. An attorney should advise you on how involved this process may be.
States have different rules. It’s one thing to get a handle on Federal rules for crowdfunding, but that’s just the beginning. The states are all over the place on crowdfunding. Under ‘Tier 1? of Reg A+, you’ll need to file your offering in every state you are prospecting in (known as ‘Blue Sky’ review). Because the Internet knows no geographic boundaries, investors may come from anywhere. That’s a lot of potential filings and a lot of complexity because each state has its own rules. To further complicate things, some states only allow companies to market to in-state investors. Heck, Montana and Massachusetts are in the process of suing the SEC for exempting the Blue Sky review on certain offerings. If you’re in business to grow your venture, get an attorney that understands the federal and state implications of crowdfunding so you can focus on what you do best.
‘Pitch time to capital’ may be reduced. Some entrepreneurs think it’s simpler to create an online fundraising campaign than to meet one-on-one with potential investors. And, if you’re not a polished presenter, an online pitch may enable you to cover key points of your business case in a less stressful platform. If you are avoiding formally raising capital because investors intimidate you, it’s an opportunity to push through your fears and learn a new skill. Selling equity in your venture—be it online or in a room—is a stressful consideration. It will be no less challenging later being accountable to a sea of faceless investors than a few you’ve built a bond with.
Crowdfunding may not draw the best investors. Capital isn’t the only value investors bring to a business. Entrepreneurs often benefit as much or more from the knowledge and experience gained from investors that understand their sector. Giving up equity means you should be getting more than an ‘ATM’—you should also be acquiring an invested partner that can help advise you. I would rather ‘hand pick’ my prospective investors than mass market to people I don’t know, who will not be adding strategic value.
Although I’ve effectively pooh-poohed the complexity of crowdfunding, that isn’t to say it won’t work for you or that entrepreneurs don’t have other means of raising capital using online platforms. The point is that the ‘securities’ nature of equity crowdfunding is getting increasingly complex. Whatever route you choose—crowdfunding or private capital—my advice is to be ‘in’ with the right crowd and always work with an experienced attorney. Raising capital is a contact sport whether there is an online intermediary or not. This is your business and your equity, not your teenager’s ‘Go Fund Me’ campaign for a new car.