Traditional crowdfunding is when an individual contributes money to a business or creative endeavour in exchange for a token gift, experience or recognition. Equity crowdfunding, meanwhile, is when entrepreneurs sell a piece of their companies in exchange for cash. Historically, entrepreneurs have only been able to raise money through equity crowdfunding from accredited investors, or those individuals who have sufficient levels of wealth and assets.
Now, your family, friends and anyone with an interest can invest in your company — not just angel investors and other wealthy individuals.
Opening up equity crowdfunding beyond accredited investors “is the greatest advancement for entrepreneurship in a generation. The single most powerful barrier to bringing great innovations and companies to life is the ability to raise capital,” “Entrepreneurs now have the opportunity to engage their customer fans as investors, who in turn become brand ambassadors.”
Gaining access to new pools of capital is one reason for entrepreneurs to be encouraged, but the new equity crowdfunding rules also have regulations attached to them and potential limitations. Entrepreneurs who are going to attempt to raise money with equity crowdfunding need to know what they are getting into before diving into an equity crowdfunding campaign.
Here’s your hotlist of need-to-know details.
- The amount you are allowed to raise on a crowdfunding platform is capped at $1 million in any 12-month period.
While that will be plenty of money for some small businesses, it’s definitely not enough to be a complete funding round for some entrepreneurs.
“Nowadays, Start-ups on average raise, at a seed stage, in the neighbourhood of $2 million. The fact that Start-ups will have a limit of $1 million per year will either force them to be undercapitalized or conduct another type of offering” says Alejandro Cremades, the co-founder of 1000 Angels, a digital platform where accredited investors can invest in Start-ups that venture capitalists are also investing in.
- Before selecting an equity crowdfunding platform, ask the portal what kind of support it offers.
There will undoubtedly be a flurry of equity crowdfunding platforms bubbling to the surface in the weeks and months following the May 16 start date. Entrepreneurs need to keep in mind not only what the crowd funding platform will offer during the course of the campaign, but also after the fundraising period closes.
“Choosing a platform is a very critical component of an equity crowdfunding investor’s journey,” “How is your platform set up to manage the investment in a start-ups post funding? Will they sit on a board? Will they provide you with investment reports and how will they provide added value to the companies they invest in? Startup companies need assistance not only to raise funding, but also require help in countless areas such as business development and raising additional funds.”
- Don’t take money from more than 480 unprofessional investors.
As the law is currently written, a small business with more than 500 unprofessional investors and more than $25 million in assets will be subject to the same regulations as a public company, which is potentially a serious burden for a small-business owner.
- Marketing is mission critical in an equity crowdfunding raise.
Launching your campaign is only the first step. Startups are going to need to have a plan to get the word out, just as with more traditional crowdfunding campaigns.
“Entrepreneurs will be faced with the challenge of standing out and being found by potential investors. Many will quickly learn that ‘Build it and they will come’ only works in the movies. Marketing an offering is rarely cheap and never easy,”
- Be careful what you say on social media about your crowdfunding campaign.
Entrepreneurs are allowed to share the name of the business they are raising money for, type of business, location, contact information for interested investors, the platform on which they are raising funds and a general description of the business. They cannot, however, get into a pitch about why investors ought to invest.
“Entrepreneurs need to understand that they cannot discuss the specifics of their crowdfunding campaign through social media. Most don’t understand this distinction. “They are specifically forbidden from hyping or promoting any detail of the offering aside from communication to investor on the intermediary platform.”
- There is going to be paperwork.
And the consequences for failing to file appropriate paperwork are not insignificant. “While regulation crowdfunding affords tremendous opportunity to entrepreneurs, with that opportunity comes responsibility,” says Miller of StartEngine. “Specifically, the procedural and substantive requirements must be followed. Otherwise entrepreneurs risk disgorgement, penalties and even possible jail time,”
The goal of the regulation associated disclosure paperwork is to protect the unwitting investor from making an uninformed risk.
“Naturally, when the SEC hears that the general public will get access to this new asset class, their biggest concern is to protect the investors — the average Joe and grandma from losing their entire life savings. So they really laid on the regulations,” says Cremades of 1000 Angels. “It’s a risk for founders to take on the burden of the upfront costs required to get prepared, from a paperwork standpoint, for a Title III offering. Financial audits, disclosures, due diligence, ongoing reporting, etc. — it all adds up, plus it takes time from the founders.”
The specific financial disclosure paperwork depends on just how much an entrepreneur is raising. Companies raising $100,000 or less must make financial statements and specific line items from income tax returns available to investors, both of which are certified by the principal executive officer of the company. Companies raising between $100,000.01 to $500,000 must provide investors financial statements reviewed by an independent public accountant and the accountant’s review report. For entrepreneurs raising between $500,000.01 to $1 million, the disclosure requirements vary depending on whether it is the first time they have raised money with equity crowdfunding. If entrepreneurs are raising between $500,000.01 to $1 million and it is their first time raising money with crowdfunding, then they have to provide financial statements reviewed by an independent public accountant and the accountant’s review report. If entrepreneurs are raising between $500,000.01 to $1 million and it is not their first time raising money with crowdfunding, then they must provide financial statements audited by an independent public accountant and the accountant’s audit report. (Audits are considered more comprehensive than reviews.)
All of the regulatory paperwork and disclosure documents may be a turnoff for some entrepreneurs.
- You have to stay in touch with your investors after they give you money.
Larger companies have entire investor relations departments. Smaller businesses that use equity crowdfunding, however, will have to manage these communications on their own.
“Communication, post-offering, is going to be very important and probably a challenge until platforms and the industry, as a whole, matures,” says Vincent Bradley “Start-ups will need better tools to help manage and communicate with their shareholders, but it will take time to understand exactly what is going to be needed to make sure companies can interact, engage and leverage their new crowd-funders as efficiently as possible.”
Author: Catherine Clifford