The Securities and Exchange Commission (SEC) reports that in 2019, out of a total estimated $2.7 Trillion dollars raised through private offerings, only $62 Million – or about 0.0023% of all private fundraising, was completed through crowdfunding offerings. Since the inception of the rules allowing for this type of crowdfunding in May 2016, through December 2019, the SEC states that 795 crowdfunding offerings have taken place with an average raise of $210,000 per raise.
Crowdfunding is a popular buzzword in today’s startup culture. After all, crowdfunding happens online and the companies who provide the platforms usually are (or were) startups themselves – it sounds like a perfect fit, and a quick and easy way to raise some money, right? However, while crowdfunding can be appropriate in some cases, the decision to crowdfund needs to be taken with the same degree of care as any other investment decision for your startup. Crowdfunding isn’t – and shouldn’t be viewed as – just a simple or modern way to inject money into your company.
To clarify, what we are talking about here is the type of crowdfunding where investors purchase stock in your company – not the kind where your backers buy a t-shirt or pay in advance for your upcoming product (i.e., Kickstarter). The type of crowdfunding we are talking about can be thought of as an alternative to (or an addition to) a "friends and family" round, or an angel investment.
Here are some of the positive aspects of crowdfunding:
- There is the potential of raising money without having to find investors yourself. The platform you work with may have a targeted investor pool, or investors may find the opportunity through an online posting.
- The third-party platform you are working with may take care of some of the ancillary work and documentation for you.
- The pool of potential investors can be larger than what you may be limited to through local investors or your network. If you are finding it more difficult than expected to locate investors through networking, crowdfunding may be a possible solution.
- It may provide an opportunity to allow individuals to invest in your company for smaller dollar amounts than are typical in other types of funding rounds.
Below are some aspects of crowdfunding that should be carefully examined before making your decision:
- Make sure the platform you use is a reputable platform. Don’t just trust the promises on their website – see if you can get information on other raises they have done. Ask for their standard form agreements. See how responsive or open they are to these lines of questioning.
- What are the platform’s fees? Platforms may take a percentage of the raise and/or a percentage of the company as payment for their service. Have you run the math to make sure that the raise is worth the fees you will be charged?
- Ask how and if the platform is vetting potential investors. Do potential investors have to certify to a certain net worth or income level? Remember that a major factor in lawsuits resulting from investments is the loss of money, or investors not feeling they received a return they were “promised.” Will the investors targeted by the platform understand that the investment is a risk?
- What is the platform going to provide for you, and what are you expected to do? In any case, you will want to strongly consider having your own legal counsel review any crowdfunding plans and documentation, which can add to the overall costs.
- Is there a minimum amount the platform is willing to agree to in order to finalize the raise? I.e., if you raise less than a certain amount, will the fees of the platform, the dilution of ownership, and attorney’s fees be worth it?
- How might crowdfunding affect future funding rounds? We recommend consulting with industry advisors on this point, and in any case, making sure that the legal aspects of the crowdfunding round are well taken care of to avoid roadblocks in the future.
Overall, keep in mind that taking investment for your company is never as simple as just accepting money from a third party, whether done through crowdfunding or any other method. At a minimum, appropriate securities laws need to be followed (state and federal), and corporate governance matters need to be considered, including (but certainly not limited to) whether you have enough stock authorized for a certain raise, the rights and preferences attached to each class of stock, and whether you have the appropriate board and/or shareholder approval to raise money.
So, when you are thinking of crowdfunding for your startup, take a step back and think about the reasons why you are considering this path. It might be the right path for you, but it is not as simple as it can often sound.
If you have any questions about crowdfunding and whether its right for you, please feel free to reach out. I can be emailed at audrey.wessel@gutweinlaw.com or contacted by phone at 317.777.7920.
