Editor’s note: So should you and your startup consider crowdfunding? A company needs the right brand elements, marketing capabilities to fully leverage such online fundraising and much more, says Joan Siefert Rose, president of the Council for Entrepreneurial Development.
DURHAM, N.C. – It’s not hype; a wave of entrepreneurship is building across the country. The 2015 Kauffman Index finds that startup activity has reversed a 5-year downward trend that began during the Great Recession, a sign that the economy and credit markets are finally stabilizing.
Where will these nascent businesses or raw ideas find capital? More and more entrepreneurs are considering online fundraising. The District of Columbia and a majority of the states now allow non-accredited investors to invest in startups located in their state, giving new businesses the opportunity to connect with thousands of potential first-time investors interested in getting an ownership stake in a promising company. Most of the remaining other states are considering similar legislation.
Those who have already decided to take the online fundraising plunge are among the first wave of startups to test the intrastate provisions of the JOBS Act (Jumpstart Our Business Startups Act), designed to provide better access to capital for everything from brick and mortar retail stores to high-tech startups.
In speaking with a number of these pioneering entrepreneurs, and founders of various crowd financing platforms, I’ve collected some important findings useful to startups thinking about taking advantage of crowd financing:
1. A company needs the right brand elements and marketing capabilities to fully leverage online fundraising. Ryan Flynn, founder of investment crowdfunding platform Localstake, recommends a company take a hard look at its brand recognition and marketing ability before jumping into crowd financing. Does the company have a dedicated pool of fans/customers who could be potential investors? Does the platform attract investors interested in similar companies? Does the company have a social media following it can leverage to put the word out about fundraising? If the answer to most of these questions is “no,” an entrepreneur may want to think twice about online fundraising as a viable option.
2. Get a lawyer. Really. This is not a do-it-yourself operation. For one thing, each state has its own rules about how much can be raised per individual. The SEC currently wants to make sure the investors and companies live in the same state to qualify for this provision. We’re still 6 months away from “crowdfunding for everyone,” and the regulations recently proposed by the SEC are more restrictive than what many advocates for national crowdfunding had hoped. For now, companies need to make sure that advertising stays inside state lines, and does not waft across the border on a radio signal. Founders may also need help with incorporation, protection of intellectual property, regulatory compliance, document preparation, and valuing shares.
3. When considering different fundraising platforms choose carefully. There are new options for listing offerings coming online every day. Some make their money by charging a fee up-front, regardless of whether the company receives any funds. Others may offer a range of professional services and take a percentage of what they help raise. Many platforms, like Localstake, have registered as broker-dealers, which allows them to help companies navigate the legal issues of fundraising, assist in matchmaking, and help companies issue their securities. If a company’s plans call for rapid expansion, a broker-dealer might be the best route.
4. Remember that these investors are owners, not donors. Unlike online fundraising platforms such as Kickstarter or GoFundMe, which allow individuals to contribute to a project in exchange for a reward or goodwill, a company’s funders become business partners. Will expectations match if the company wants to raise money from other investors at a later date? Or if the founders want to sell the business? Companies should think about how often they want to communicate with investors, because if they’re like most startups, the investors will be along for the ride for at least 3, and possibly 7 years.
It’s still early days for non-accredited investor crowdfunding in the U.S., so analysts tend to look to Europe and Australia, where such platforms have been around for a number of years, to predict what may happen here. The good news is that there have been few instances of investor fraud reported, so there is faith in the integrity of the system. The data also show, however, that only about one in 5 equity investors are repeat investors, which indicates crowdfunding is still perceived as something of a novelty, or is not as attractive as other investment options for “average” people.
And the rules are still in flux. Although state crowdfunding laws are only a year or two old, the SEC proposed regulatory changes in October that could benefit tech entrepreneurs who want to build fast-growing companies. The new proposed regulations allow businesses to raise up to $5 million by advertising and selling to both accredited and non-accredited investors. Initially, the SEC placed many restrictions on the types of businesses that could use state crowdfunding. It was available only for truly local businesses. Growth businesses that focused on bigger markets were substantially excluded.
According to Jim Verdonik, an attorney at Raleigh, NC-based Ward and Smith, PA, and the author of an upcoming book on crowdfunding, each state will need to change its crowdfunding laws to adapt to the new rules, which cover both in-state and multi-state crowdfunding. It raises the question: Will the states cooperate with one another or try to wall off their economies by using their new laws to direct local investors to invest only in local businesses?
Entrepreneurs will continue to have more opportunities than ever before to connect directly with potential investors, and that’s a good thing. It’s up to companies, however, to educate themselves on the options to fuel their growth – heed the experience of others before committing to any one path.
Note: This post was originally published at Forbes and is reprinted with permission of the CED.