On May 16th, the law changes: startups can raise up to $1 million per year from their friends and supporters, who can invest as little as $100 each. (Before, companies could sell products on Kickstarter, but not stock).
This is part of the “Regulation Crowdfunding” portion of the JOBS Act, a bill passed by Congress in 2012, which is just now being fully implemented four years later (the government moves slow!).
This new federal law gives founders another lever they can use to get funded. Capital no longer has to be constrained by the traditional gatekeepers in suits — the risk-adverse bankers or the out-of-touch venture capitalists investing in the next hot “app” like a herd of cattle. In a way, this law brings back how companies were funded 80+ years ago: by their friends, neighbors, and local communities. Not some conglomerate bank headquartered on Wall Street that treats you like a FICO score.
However, as exciting as the potential of Investment Crowdfunding is to allocate capital to more deserving businesses more fairly, this is serious business: securities regulations are complex, and doing it “wrong” can hobble and possibly destroy your business.
So let’s take a clear-eyed look at the opportunities and dangers of using Regulation Crowdfunding. If you decide to do it, make sure you do it “safely” so that it won’t negatively impact your company down the road.
For a small business trying to open on Main Street, there might be no other good option — Banks don’t take much risk anymore. However, let’s assume a few “angel investors” or venture capitalists are knocking around your door, and you have other options to raise funding. Why crowdfund also?
The Regulation Crowdfunding law isn’t perfect, and while the SEC did a great job overall in drafting the final rules, they messed up in two key areas. Congress is in the process of fixing it with the Fix Crowdfunding Act.
However, until Congress acts, founders who crowdfund must take two safety precautions above all else:
If a company crowdfunds without these protections, it could endanger (and certainly slow down) their follow-on financing when they raise a Series A financing from venture capitalists. No one wants to be in a position where they have to chase down 480 signatures to raise a round of funding or get acquired (and God forbid if you have to be a public reporting company).
However, with these protections, in the very worst case scenario, a venture capitalist firm ideologically opposed to a “messy cap table” (even though there are no voting rights) can simply repurchase the crowdfunded securities during the deal. With this power, do you think a venture capitalist would have honestly walked away from Oculus if they raised with equity crowdfunding instead of with pre-sales on Kickstarter?
While the two issues above are the most serious, there are other issues that a company needs to be aware of — the Wefunder Founder Legal Primer has a good overview. Here, I’ll deal with the issues relating to cost and time.
Founders can fundraise with an equity crowdfunding campaign safely without negatively impacting their follow-on financing… but only if they choose an experienced funding portal and law firm. In summary, until Congress passes the Fix Crowdfund Act, choose a funding portal that:
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