While SPACs stole the road show during the pandemic, and venture capital remains the go-to for nascent unicorns, one financial expert says that young companies should still consider crowdfunding. In 2021, crowdfunding campaigns raised over $1 billion, up nearly 10% from the year before. The secret to its staying power, according to Jay Jung, CEO and founder of investment banking consultancy Embarc Advisors, is its broad appeal.
“Equity crowdfunding platforms democratize startup investing and fundraising,” Jung says. “Startup investing used to be exclusive to high-net worth individuals, angel investors, and VCs; but now, anyone can invest with bite-sized checks. Crowdfunding levels the playing field and creates an environment where the best idea or team has a winning chance.”
While certain methods of equity crowdfunding have been possible for some time, the process was made far more accessible by the JOBS Act, which President Obama signed into law ten years ago. The legislation lowered reporting and disclosure requirements for companies with less than $1 billion in revenue. It also allowed some crowdfunding campaigns to target non-accredited investors.
Crowdfunded equity has been especially successful for new products that are gaining traction in the marketplace because users can participate in the equity raise and spread word of mouth. Still, Jung warns, crowdfunding is not like listing your home on Zillow or posting a used TV on Facebook Marketplace. Like an IPO, it requires extensive preparation and marketing. “Think of it like a Kickstarter campaign, only harder,” says Jung.
Why harder? With a crowdfunding campaign, companies are selling to the masses via a scalable digital platform. They not only need a great idea/product/service, but a compelling story. They’ll also need answers to a lot of hard questions such as: What is the story behind the vision, strategy, the team? What is the product roadmap? Where is the sales and marketing plan? How does this all tie into financial projections?
Jung says that developing a highly compelling comprehensive narrative is key to the success of any equity raise. Think Shark Tank, but with more judges — and a lot more competition. Thankfully, while smaller companies don’t have the budget or the backing to go on an IPO-type road show, the JOBS Act does allow them to advertise. Jung suggests first finding a large anchor investor in order to lend credibility to the marketing campaign. “Sometimes we will see a $2M raise with an anchor investor coming in with a 10-30% of the offering,” he says.
Like SPACs and IPOs, equity crowdfunds are regulated by the Securities and Exchange Commission (SEC), so there are rules. First off, a company can only crowdfund online through an SEC-registered intermediary, meaning an approved broker-dealer or a funding portal. Beyond that, the regulations vary based upon the company’s situation. The major categories are Reg CF, Reg A+ and Reg D. Each carries implications regarding marketing of the offering, future reporting requirements, and future capital raise implications. Jung says it’s important to figure out the right fit early on in the process.
Regulation CF is embedded in Title III of the JOBS Act, which actually went into effect in 2016. It stipulates that, 1) The funding group must be incorporated into the US and must primarily do business in the US or Canada; and, 2) Companies may raise up to $5 million annually through both accredited and non-accredited investors. Generally, Reg CF is a good option for companies hoping to raise a small amount of capital.
If you need more money, Reg A+ is a better choice, but the flipside is increased disclosure, which depends on which tier is chosen. Tier 1 companies may raise $20 million and are subjected to a financial review; while Tier 2 companies may raise up to $50 million, but must provide audited financial statements. In both cases, the SEC imposes limits on how much stock may be sold by existing shareholders.
Regulation D is a set of exemptions for businesses looking to raise larger sums of money without going through the rigors (and expenses) of an IPO. Regulation D campaigns can be equity or debt raises, but shares can only be sold to so-called accredited (i.e., higher-net worth) investors.
In addition, Jung says that executives must consider the type of security that would best fit their company at its current stage, as well as which crowdfunding platform to use. While most of the major platforms purport to offer a broad range of options, each tends to be stronger in certain areas and not as strong in others. For example, WeFunder and StartEngine do not perform additional diligence, but attract the most volume. SeedInvest is more curated through its thorough due diligence process, and is better suited for larger capital raises for companies that are further along.
While crowdfunding may seem easy thanks to the popularity of sites like Fundible and MicroVentures, Jung warns that equity crowdfunding has unique challenges. For instance, some future institutional investors may cringe when they open up the cap table to find hundreds of names with small amounts. While too much interest may sound like a good problem to have, taking on too many investors may trip alarms at the SEC, which can lead to serious costs and compliance headaches down the road if not managed properly. In response, several equity crowdfunding platforms have introduced workarounds that allow the investors to be aggregated as one registered shareholder.
Overall, experience matters when crowdfunding equity and success will depend on making the right choices. “When you don’t have an investment bank or law firms doing all of the work for you, it’s always good to do your homework,” Jung says. “A poorly-designed crowdfunding campaign can make the marketing process difficult, and may cause costly headaches down the road that will be very hard to rewind.”