From a British Rock Band to Unicorns, Crowdfunding is Changing the Funding World
Something interesting is happening in the world of business funding in the United States. Changes to regulations that took effect on March 15th, 2021 mean companies are now able to raise up to $5M using Regulation Crowdfunding instead of the previous limit of $1.07M. That is a significant change and dramatically improves the effectiveness of such an investment vehicle.
Crowdfunding has been around for a while. The first recorded successful instance of crowdfunding occurred in 1997 when a British rock band funded their reunion tour through online donations from fans. We’ve since seen it go on to fund companies that achieved unicorn status ($1B+ valuation) like Checkr and Zenefits.
With the changes to the limits and the success of companies who raised using crowdfunding, it’s no surprise that it’s proving to be a very valid way for companies to raise the capital they need. I know with seeing the success and the opportunity that this has certainly changed my perspective on raising capital.
A New Opportunity with Non-Accredited Investors
At the last business I founded, Talent Rover, we raised $28M in funding, with $25M of that coming directly from angel investors. At the time I didn’t realize that this was considered an unusual way for a company to raise money. To be clear, raising from angels is not unusual, but raising $25M from them is. One challenge we had with raising from angels though was the requirement for them to be an accredited investor.
According to the SEC, an accredited investor is anyone who either earned income of more than $200,000 (or $300,000 together with a spouse) in each of the last two years and reasonably expects to earn the same for the current year; or they have a net worth of over $1M, either individually or together with a spouse (excluding the value of a primary residence). The SEC has this rule in place to protect the investors. They are wanting to ensure that all participating investors are financially sophisticated and able to fend for themselves.
Crowdfunding regulation and platforms are now making it possible for non-accredited investors to participate in investing in early-stage companies. The SEC does have restrictions on the total amount an individual can invest if they are non-accredited, but they are able to participate.
These equity investments can be attractive to non-accredited investors for a variety of reasons. There is a potential for a solid return if the company performs well — imagine those early investors who participated in the crowdfunding for Checkr or Zenefits. The other big element here is you typically can invest a small amount, sometimes as little as $100, so it makes it a bit economical.
From a company standpoint, utilizing a crowdfunding platform is also very attractive as it not only gives you a new investor pool to pursue, but equally important, the crowdfunding platforms make it extremely easy to manage. Typically the platform will have all of the investors invest into a special purpose entity, and then that one entity becomes the investor on your company’s cap table. Explaining that a bit more, if you have 1,000 people invest in your company directly it is an administrative nightmare, but having those same 1,000 people invest on a crowdfunding platform that burden is the responsibility of the platform and your company still receives the benefit of the investment.
One big thing I learned from building companies, and life in general, is that everyone has an opinion. I’ve also learned that I really value opinions, but I treat them as one data point. In any big decisions, I like to gain as many data points as possible to help influence my thoughts and actions. With that though, not all opinions (or data) are correct or equal. The key is to be able to understand what is the basis for the opinion. Funding is no exception to this and I would highly recommend seeking opinions from people who successfully built companies in a similar space.
With my new business, Place Technology, I initially set out to raise from angel investors, but I also knew that I wanted to bring an institutional investor in as well. There are pros and cons to both and I received many opinions on what route to take. Ultimately I decided we are going to tackle this by leveraging a few different options, and one of these options now includes crowdfunding.
Angel investors are a vital part of our fundraising strategy. These individuals are typically highly successful business professionals that offer tremendous value outside of just the cash they are investing. They essentially become business advisors who have a vested interest in the success of the company. As of now, the majority of funds that we’ve raised at Place have been from angels.
- Pros: Smart investors that can provide solid business advice, they also typically require less due diligence and it’s a faster process.
- Cons: Usually you get one check from them and should not depend on them for future investment. In my experience, many angels will continue to invest if you build and maintain a healthy relationship of transparency and trust. Raising from angels can also take a lot of time for the founder, as you will have a lot of pitch meetings where you explain and sell the opportunity.
Bringing on a venture partner was a critical part of my fundraising strategy for Place. In the later years at Talent Rover, we started to have some challenges with large prospective clients being concerned that we were not venture-backed. Additionally, I wanted the structure that having a venture firm involved in your company brings. If you find the right partner this can be immensely valuable.
When we did our seed round in 2019 I was fortunate to have term sheets from multiple firms, and ultimately chose Geekdom Fund. I chose them because I had the ability to develop a relationship with one of their managing partners. They had invested in a company that I angel invested in, so I saw for a full year how they interacted with that company. While this might not be an option for everyone, I would suggest finding a way to develop relationships with potential firms prior to needing an investment. Currently, I’m nurturing relationships with several firms that I would be interested in having them invest in our Series A next year. The extra effort I need to spend is worth it to give me confidence and understanding of who they are and how they operate. It also gives them a chance to do the same with me.
- Pros: Typically larger checks and capability for follow on investment. They will offer additional value with business process, network, and organization.
- Cons: Due diligence process is much more involved and detailed. You will usually have to convert to a C-Corp vs. remaining an LLC (this impacts your personal taxes) and also create an official board of directors — in which they expect a board seat. Similar to angels, raising from VCs is a time-consuming process that requires a lot of pitch meetings — and a lot of rejection.
The latest addition to our funding strategy is launching a crowdfunding campaign on WeFunder. When I began exploring crowdfunding I randomly cold-called several CEOs at companies who had raised at least $1M on one of the sites. The feedback was consistently positive, often I heard that “it was the best way I’ve raised money”. I’m excited about it because it extends the investor pool and I really like the idea of anyone being able to take advantage of what could be an incredible investment opportunity.
- Pros: A very large investor pool. Crowdfunding sites do most of the heavy lifting. Unlike angels and VCs, the founder’s time is not consumed with pitches.
- Cons: Pretty extensive disclosures and legal filings need to be made publicly available. It also requires heavy marketing and advertising to attract investors to your listing.
At the end of the day, all investors care about one thing — performance. Surround yourself with really smart people who have experience with raising capital in your type of industry. Leverage their opinions to help you decide which direction to go. I would speak to a tax attorney and CPA, as you need to understand how the structure of your raise impacts your personal taxes.
Focus on raising the capital as quickly as possible, as your number one job is to have the company achieve or exceed your targets, and fundraising will distract you from it. You can raise all the money in the world, but if you don’t have sales and customer retention it won’t matter.