Should CEOs Crowdfund Equity?

Despite America’s private capital markets being strong and active, not every entrepreneur or business owner has access to the capital they need. Thanks to the Jumpstart Our Business Startups (JOBS) Act, in partnership with the SEC, any privately-held company can now raise up to $1 million from non-accredited investors over 12 months through equity crowdfunding.

These new rules, which went into effect in May of this year, certainly lower the barriers for raising capital, but aren’t without risk to both the investor and the founder/owners.

In this post, we answer a few of the most common questions we’ve heard about crowdfunding from CEOs on Axial.

What should I know about potential crowdfunding investors?

As Axial member Russell Malcolm of 12five Capital notes, there’s an important distinction to recognize regarding the definition of Accredited Investor. “Before the bill, only ‘Accredited Investors’ were eligible to invest directly in companies for equity, and this definition basically meant only people with over $1M in net worth were eligible,” says Malcolm. “Now, almost anyone is able to invest.”

While crowdfunding allows a company to raise a significant amount of capital without executing any notes or selling any shares, business owners will still want to align themselves with a lawyer or consultant for assistance with diligence. For example, an equity crowdfund with 50 new investors will likely be overwhelming and distract from day-to-day business. CEOs engaging in a campaign will have to consider rewriting bylaws and declaring state of returns — decisions best made with assistance of professionals.

Is my business a good fit for equity crowdfunding?

In order to decide if crowdfunding is right for your business, you must consider what options you have available after the capital raise. Most companies seek crowdfunding at an early stage, then work to establish a customer base and revenues, before raising capital from venture capital or institutional investors.

Looking across all industries, Crowdfund Capital Advisors found that “43% of those who were successful in the crowd fundraising were later in discussions with institutional investors.” But if you own a middle market company that already has established a customer base and revenues, you may benefit more from skipping the crowdfunding round and hiring an investment bank who can help source institutional capital that is traditionally harder to reach.

Businesses that are easy to understand and have a clear value proposition are likely the most viable equity crowdfunding prospects. In an article with Marketplace, Venture.co CEO Aaron Pollack says, “If you’ve got the next brilliant molten metals technology for 3-D printing or the next greatest silicon chip design, then it’s probably not a great fit for crowdfunding.” However in 2013 hardware companies creating products such as medical devices and wearables saw great success in crowdfunding. CB Insights reported that 9.5% of successfully crowdfunded hardware campaigns went on to raise venture capital later.

What benefits aside from capital can equity crowdfunding provide?

Many entrepreneurs and business owners credit crowdfunding for spikes in marketing or sales. But if you’re a business owner considering this option, don’t jump at the opportunity too fast. You still must file your offering materials with the SEC prior to setting up a campaign. It’s also generally recommended for you to think strategically about how and what you communicate about the equity you hope to crowdfund in the event that your campaign gains the traction you’re looking for.

While you may develop a new customer base in part thanks to the crowdfunding campaign, one common misconception associated with the word “crowdfunding” is that the money must come from individuals. Institutional investors seek out new opportunities to deploy capital by looking through sites like TruCrowd, CrowdFunder, Fundable and Kickstarter. These new rules allow the sites to perform both as a capital raising marketplace as well as a vehicle to promote great ideas and initiatives.

Still have questions? See the SEC resource site for details on Crowdfunding (Title III).