Crowdfunding Basics

While we have been speaking about SBA and PPP options to get businesses through the challenging period of Covid-19, there is an additional type of funding that might interest some business owners who are looking to grow in the months and years ahead: crowdfunding.

While most people have become familiar with the principle of donation crowdfunding via websites like Kickstarter and Indiegogo, and debt crowdfunding via Lending Club and Prosper, many are unaware that the 2012 Jobs Act signed by President Obama got the ball rolling for equity crowdfunding.

Equity Crowdfunding

Equity crowdfunding is exactly what it sounds like: giving up equity in your company to people from the general public who are interested in funding you.  While the legislation was passed in 2012, it wasn’t until 2015 when the SEC adopted final rules for equity crowdfunding that platforms eager to help business owners could really get going.  

By making sure that crowdfunding backers were actually purchasing securities, the SEC de-risked both sides of the equation: business owners couldn’t just put up any project to get funded, and potential investors were given full risk disclosures so they couldn’t complain later on that they didn’t know what they were getting into.

Pros

Using equity crowdfunding, business owners can obtain funds they need for no credit or collateral.  They will sometimes get enthusiastic ambassadors for their company in the persons of the investors.  Studies also show that equity crowdfunding tends to skew local and regional, so that also means there’s often a community connection with these backers.

Investors have the chance to invest in small and medium sized businesses without having to earn the title of “accredited investor.”  They get to be involved, even if it’s in a small way, with a small business, and they have many different industries they can choose from.

This doesn’t mean there aren’t downsides to raising money this way.

Cons

For investors, the wait for a return on their investment can be longer than they are used to, particularly if they have mostly spent time in the stock market, where ups and downs can be more easily tracked and, sometimes, understood.  The securities are also illiquid, as there isn’t (yet) a secondary market for these shares.  Finally, investors can still get quite diluted, especially if the business decides to go on for angel or venture funds after a successful crowdfunding raise.

There are downsides for business owners too.  Firstly, a crowdfunding campaign is precisely that: a campaign.  You’ll need to put together media, collateral, and a clear message as to why you need these funds and what kind of return can be expected.  That takes time and money.  Of course, too, there’s the reality that you are giving up parts of your business, which, even if you’ve only made it a small percentage, will still come with certain legal compliance costs.

Platforms

The equity crowdfunding market is still pretty new so there is no Google or Amazon in the space yet.  Websites like WeFunder and Localstake offer minimum investments in projects as low as $100 and $250, respectively.  Localstake even has some sophistication in their equity crowdfunding, offering revenue shares, convertible debt, or preferred equity as options.

Other sites, like Crowdfunder and Fundable, are simply advertising platforms and don’t serve as a medium for transactions.  Investors make nonbinding pledges and transactions happen offline.  Fundable even offers help (paid, of course) with your pitch construction and prospectus.

Choice 

While we’ve spent most of this article discussing equity crowdfunding, the reality is that businesses are still free to use donation crowdfunding instead.  Those businesses can gauge customer interest in a new product by creating a crowdfunding page for it and if existing or potential new customers “vote” enough for it by prepaying, you can have the confidence to move forward, as you’ve essentially created a fully funded purchase order.  

Crowdfunding isn’t for everyone, either on the investor or business owner side, but there have been some good success stories so far.  This book chronicles twenty case studies if you’re looking to learn more about the field in general.

Are you unhappy with your banking relationship or are you looking for some alternative funding options?  Give us a call: we’d love to connect you with the right people.