Monday, October 1, 2012

Lesson #123: Crowdfunding Details Starting to Emerge

Posted By: George Deeb - 10/01/2012


& Comment

Last week, I had the pleasure of sitting on a crowdfunding panel with Sherwood ("Woodie") Neiss, a serial entrepreneur and one of the original authors of the crowdfunding bill, who was meeting with Chicago's startup entrepreneurs, investors and service providers to gather our input on what desires we have for specific language to be incorporated into the Jobs Act.  Woodie was then going to take Chicago's collective comments, along with the comments from other startup regions around the country, back to the White House, so the President can get a better sense of what the startup ecosystem is looking to acheive via this law, and lawmakers can incorporate such goals into the law.

As part of this discussion, Woodie also presented some more details about where the current drafts of the law are heading.  Understanding this is still a moving target at this point, it should help you better understand whether crowdfunding is a good financing choice for your startup.  Please re-read my original blog post on Crowdfunding Startups as a refresher on what we are talking about here. 

Below were some of the highlights I took away from the presentation, as it relates to startups:
  • You must be a U.S. based startup--foreign issuers will not be allowed
  • Funding must be pursued via a registered crowdfunding portal or broker-dealer
  • You can be either a C-Corp or an LLC, corporate structure does not matter at this time
  • You can raise up to $1,000,000 via a crowdfunding effort, although bigger raises come with  higher requirements
  • But, don't ask for too much, as it is "all or nothing" in order to close your financing--you need to raise the full amount asked for, before funds will be released to you
  • Financings over $500K require a full accounting audit; financings over $100K require a CPA review; financings under $100K require a CEO letter speaking to financials
  • You will be held to strict monthly financial reporting requirements (via compliance tools)
  • It is still being determined if you can run "parallel financings" at the same time (e.g., concurrent equity and debt), but you can only raise equity on one portal site at a time
  • You will be limited to general solicitation of investors only (e.g., via your social networks)
  • You can have an unlimited number of investors participate in your financing
  • Investors are limited to $2K for up to $40K income; 5% of income for $40-$100K income; 10% of income for over $100K income (up to a total cap of $100K invested per year)
  • Investors can live anywhere--foreign investors are allowed to invest in U.S. startups
  • Shares issued could be either voting or non-voting stock, depending on your needs (still TBD)
  • Funds raised could be either direct shareholder investments, or via a special purpose entity which aggregates all investors into one investor pool for simplicity (still TBD)
  • There will be a one-year holding period for all investors in a crowdfunded startup
  • Thereafter, it is anticipated that a "secondary shares" market will develop to sell your shares
  • Full background checks will be performed on the CEOs of all companies raising funds
  • It is anticipated there will be 100's of crowdfunding portals to choose from, both generalists and niche specific (so choose carefully based on reputation and industry)
  • It is anticipated that crowdfunding will work best around "community driven" initiatives (e.g., local town wants a new restaurant, and those citizens finance and use such restaurant)
I am still a huge fan of crowdfunding, as it will fill the financing hole until your product is built and "proof of concept" is acheived before the traditional venture capital investors take interest.  And, it will open up more startup capital outside of the tech industry (e.g., retail, CPG), where VC's typically do not play.  But, buyer beware.  As you can read above, it does come with a lot of strings attached (e.g., 1000's of investors to keep happy, primarily from your social network of friends, monthly reporting requirements).  Not to mention, this is simply "dumb money", as crowdfunding investors are most likely not coming in with a Rolodex of relationships or past startup experience to help you build your business (which is preferred).  That said, I am feeling better fraud will be kept in check based on the auditing requirements, the required background checks of CEOs and startups having to rely on their own social networks of friends to solicit investors.

If you would like to read the full act, click here.  If you would like to read a high level summary on the act from the SEC, click here.  If you would like to read comments on the act submitted to date, or you would like to submit your own comments for lawmakers to consider, click here.  Lawmakers are particularly focused on six areas: (i) how startups communicate the offering and spread word; (ii) how to mitigate fraud within social media; (iii) how to avoid a "messy cap table" for future VC's; (iv) how underserved communities can access capital; (v) how to build a local ecosystem for success; and (vi) how best to educate investors on startups in an "eyes wide open" way.  So, feel free to chime in.

Historically, small businesses are responsible for 50% of our country's job creation, and funds available to those startups have only represented 1% of the available capital. Hopefully, crowdfunding will help to rebalance this, and we can finally get our economy and job creation back on solid footing.

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