Looking Back On A Year Of Crowdfunding
What are the pros and cons of crowdfunding for startup companies seeking capital?
One year ago, I wrote a column about crowdfunding to mark the enactment, after years of delay, of the SEC’s crowdfunding rules. Here is a quick synopsis: Regulation Crowdfunding allows companies to raise up to $1 million from unaccredited (and accredited) investors without having to register the securities as required in an IPO, and companies have to use an “intermediary,” which is either a broker-dealer or a funding portal, but either way to the casual observer it’s just a website with a lot of information about the companies.
As a business lawyer with startup clients that are always looking for funding, crowdfunding had been on my radar for a while. I was fortunate to have been asked to write the client alert for the JOBS Act – which authorized a crowdfunding registration exemption – at the last firm I worked for (the normal person was on vacation that week and I happened to be in the office when the head of our group was wandering the hallways looking for suckers volunteers). I wasn’t sure how it would work in practice and didn’t want to hitch my wagon to it, but I was an interested observer.
Then last summer the former GC of a client sat me down one day and told me I was about to become a crowdfunding attorney. She had started a crowdfunding platform and wanted us to handle all the securities filings for the companies raising money on her platform. Since then we’ve done just that, and combined with our company-side crowdfunding clients, my tiny firm has handled about 20% of the successful crowdfunding offerings to date. So I thought perhaps I’m in a position to give a few thoughts on the first year of regulation crowdfunding.
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It’s not an easy one million. The maximum a company can raise is $1 million (now technically it’s $1.07 million, but that doesn’t roll off the tongue quite as well), and the first question many companies ask me is what happens if they’re able to raise more. They just assume it’s going to be a quick million. Boom! One million dollars. Just like that. However, out of over 160 offerings, I think only three reached one million. So while it’s possible, it’s unlikely and not something a company should plan for. A more realistic goal is $150,000 to $200,000. (The median thus far has been $171,000.)
Financially, companies are probably better off pursuing angel investors. To raise $180,000 from people who are investing only $100 apiece, a company needs to be able to attract 1,800 investors. How many eyeballs will it take to reach that 1,800? After all, only a fraction of the people who see any one offering are going to invest in that offering. I know the answer: lots and lots and lots of eyeballs! And it’s going to take a lot of work on the company’s part (see below). From a straight cost-benefit analysis, it is probably better for a company to spend that time stalking hunting down angel investors and getting three of them to invest $60,000 apiece.
Visibility. So given the above observation, why should a company crowdfund? Am I anti-crowdfunding? Not at all. It’s a good way for companies to gain national exposure, which a company doesn’t necessarily get from angel investor funding. It can also help test a product or concept and the related pitch. Though under the rules there is no minimum target amount, most platforms set the minimum target offering amount at around $50,000. If a company can’t reach that, then perhaps it’s time for them to turn inward and start asking some hard questions.
Platforms are like publishers. Meaning, they will list a company’s offering, and when they are trying to get a company’s business they’ll whisper all sorts of sweet nothings about how much traffic they get and how people will flock to the company’s offering and will invest big chunks of money in the company. In reality, most of the burden for making an offering successful will fall on the company, the same way after a publisher publishes a book they expect the author to get out there and sell it.
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Not for B2B. B2B means Business to Business, and contrasts with B2C, which means Business to Consumer. A successful crowdfunding has to be something that captures the average person’s imagination. Some of kind of back-end product that, say, reduces the cost of microwaves by 5% probably won’t do that.
Not all platforms are alike. Some do a lot of hand-holding for companies. Some expect companies to figure it all out for themselves. Others are misinformed as to the securities laws and don’t understand what they can and cannot do. There is no single platform that is right for every single company, so companies should talk to several and go with who they feel most comfortable.
House in order. On the whole, crowdfunding is a good process for companies to go through. The information that is requested in the Form C (the document that is filed with the SEC) is not terribly intrusive, but is information that few early-stage companies have had to go through the process of gathering. It forces a company to nail down its cap table, to have its finances reviewed, to think hard about its valuation, to state honestly how many employees it has and who is involved in the company, to give a fair business prognostication, and to admit the risks of investing in the company. Even if a raise is not successful or does not garner as much as the company had hoped, the company now at least has its house in order, which is only going to help with other funding sources, customers and vendors.
I definitely see a lot of momentum, and part of it is that companies are becoming more realistic about crowdfunding and whether it’s right for them, and another part of it is that platforms are starting to figure out where they fit in the market. It’s going to be interesting to see what the crowdfunding landscape looks like in another year.
Note: all figures are taken from the SEC white paper U.S. securities-based crowdfunding under Title III of the JOBS Act, written by SEC economists Vladimir Ivanov and Anzhela Knyazeva and dated February 28, 2017. (Vladimir was educated in my home state of Tennessee — one of our greatest states — so you know his stuff is solid.)
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Gary J. Ross is a partner at Ross & Shulga PLLC, which he co-founded in 2017 after running his own firm for four years and after several years in Biglaw and the federal government. Gary handles corporate and securities law matters for venture capital funds, startups, and other large and small businesses, as well as investors in each. You can reach Gary by email at [email protected].
