For startups looking to raise capital, crowdfunding looks to be to a modern solution to capital-raising concerns. In 2015, the SEC issued a rule on crowdfunding (“Regulation Crowdfunding”), which exempts companies from the lengthy registration requirements necessary when offering a sale of securities, including a sale of the company’s equity to the public. Regulation Crowdfunding allows unaccredited investors to invest in companies and allows such companies to raise up to $1,070,000 in a 12- month period through a registered portal.
Here are a few of the risks startups should consider when deciding if crowdfunding is the right option to grow your business:
- There is no guarantee the entire offering will be funded. Platforms typically do not guarantee to “fill the offering,” which means you could raise only a percentage of the capital needed to grow your business or complete a deal, and still be in the position of looking for alternative sources of money or foregoing the growth strategy.
- Crowdfunding is not cheap. Most crowdfunding portals charge issuers a subscription fee to list investments on the platform, sometimes a percentage of the total capital the issuer is attempting to raise. For a $500,000 offering, this 5-10% fee can dilute the return and profits raised.
- The required disclosures can be complex and are not to be overlooked. Because most investors on crowdfunding portals are not classified as Accredited Investors under the federal security laws (meaning they have a lower income and net worth), startups must file a Form C offering statement with the SEC. This statement includes, among other things, detailed information on the issuer, the offering, and the company’s financials. The higher the offering amount, the more detailed the financial disclosures have to be (and, in some cases, may even have to be audited). Because investors (who are often inexperienced) will be relying on this information filed with the SEC, it is important issuers not simply fill in an online template but consult an attorney, preferably with experience in securities regulation, to avoid legal ramifications or lawsuits down the road from either investors upset their investment turned out poorly or the SEC for failure to comply with all applicable rules. In addition, for startups only looking for Accredited Investors, there may be better alternatives, with fewer restrictions, under different exemptions from the registration requirements.
Issuers should have a clear understanding of the scope of crowdfunding and what the company is entering into before signing up to crowdfund growth and expansion. That said, crowdfunding can be a useful tool to raise capital and move to the next level for an established startup. A company should carefully consider all funding and capital-raising options before selecting a strategy.