Crowdfunding – Prepare your Company to Crowdfund

As I’ve discussed earlier, the SEC is now preparing regulations to allow for Crowdfunding pursuant to the recently passed JOBS Act.  These should be done by 2013 (emphasis on should be done by then – we’ll see when they actually come out).  As you may have heard, it will allow for true equity sales over the World Wide Web.  Companies will soon be able to sell shares of their corporation (or LLC) through online portals to regular persons that are not accredited investors (i.e. not millionaires or otherwise sophisticated).

There are a couple of things to discuss, the first is whether this is something your company actually would want to do.  The second item is, if it is something you want to do, then what can you do to prepare your company to do a Crowdfunding raise in 2013 (or whenever the SEC finishes the regulations).

Here are a couple of factors that may indicate that raising money through Crowdfunding may be for you:

  • Your company is not yet at the stage where it can raise its own revenue through sales of your goods or services. Sometimes to get to the point where you can make money, you have to spend money.  If you are at this stage then Crowdfunding may be something to look at.  Admittedly, most startups face this at some point in their life cycle.
  • Angel investors and venture capitalists, for whatever reason, are not interested in investing in your company.  If you have the option of going with investments from angels, VCs or other accredited investors, you probably should avoid Crowdfunding and stick with the traditional route of investing if you have that option.  Sometimes investors will not be interested because your company may have too new of a technology, or be too out there for them, or not fit into their niche.  There are a lot of promising companies that the traditional investors will pass on, because they have their own investment criteria.
  • You won’t need, or will be seeking, investments from institutional investors in the future.  It is very likely that any company that raises money through a crowdfunding round will be slightly less attractive to institutional investors, as after the crowdfunding the company will have much more compliance to undertake on a regular basis (see next point).  Unless your company is hot, it may scare away traditional investors.  If you can raise enough funds through crowdfunding alone, either just one round in the beginning to get enough startup capital, or through multiple rounds of crowdfunding, then crowdfunding may be for you.
  • You don’t mind, or can live with, dealing with numerous shareholders, most of which likely won’t be sophisticated.  Any company that raises money via crowdfunding will require meticulous records, will need to follow many more corporate formalities than other companies their size will require (it appears the SEC could treat it similar to a smaller IPO in some respects), will need to have actual shareholder meetings, and all of that will lead to increased legal and accounting bills throughout the life of the business.  Also, most of the shareholders will be non-accredited investors, and these individuals are generally less sophisticated and not as comfortable losing money as accredited investors are.  They may not be as patient to get a return on their cash, nor as understanding with any business setbacks, even if the setbacks are only temporary.

Don’t let the tone of the factors above tell you that raising money via Crowdfunding is a negative.  It is not.  They are just things to think about. There is a reason Congress is allowing Crowdfunding, and it is because there are a lot of exciting and promising businesses out there that don’t have access to the startup capital they need to grow, whether it be angel, VC, or traditional bank financing.

Now if you think that Crowdfunding is something you’d be interested in, then you should take the next steps to prepare for a Crowdfunding raise.

To prepare to raise money via Crowdfunding you should take the steps that any business takes when it is trying to raise money.  If you don’t have a business plan yet, then you should get one ready as soon as possible.  Tap into successful local entreprenuers to assist you.  There are also generally a good deal of assistance that can be found to help with drafting a business plan.

Further you must get your finances in order.  You should prepare a cash flow projection, showing when you believe your company will begin to make money, how much it needs to spend on what to get to that point, and all of the company’s projected cash inflows and outflows.  If you have revenues now, then be prepared to have financial statements prepared, at least a balance sheet and profit and loss statement.  You should sit down with your company’s advisors (business, accounting and legal) and determine a preliminary valuation of your company, how much money you are looking to raise, and how much equity you would be willing to offer (and hence at what price).   It is also a good idea to prepare items that would normally be included in a private placement, such as risk factors for your company’s industry and your company specifically.  It’s safe to bet that the SEC will require a good deal of disclosure to prospective investors prior to a Crowdfunding raise.

All in all, it is exciting times in the startup world.  Many people are looking forward to the publication of the Crowdfunding regulations by the SEC.   Make sure to get your company in order to take advantage of it.