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A Quick Primer on Title III Equity Crowdfunding: Is Equity Crowdfunding Right For Your Startup? (Part 2 of 3)

Even though equity-based crowdfunding is now legal, it might not be right for you.

Even though equity-based crowdfunding is now legal, it might not be right for you.

This is part 2 of our series on equity based crowdfunding.  Let’s take a step back from the brave new world of equity crowdfunding and think back to the existing model of getting early stage funding through networks of angels and VC’s. Hasn’t this system worked until now, and will startups be missing out if they stray from the beaten path?

We’d be remiss to forget that angels and VC’s provide more value than just capital. Experienced investors will challenge your assumptions and send you back to the whiteboard a few times before providing capital, which can ultimately improve your business outlook in the long run. Post-financing, these investors also serve as valuable mentors and advisors, providing expertise and a rolodex of people that can help your business blossom. And even though these investors are loathe to sign confidentiality agreements, you’re generally safe to meet with these folks with the understanding that your financials won’t wind up in the hands of a competitor. All this is to suggest that simply because you might no longer need the traditional conduits for seed capital, it doesn’t follow that they won’t be one of your better options.

But rather than compare crowdfunding to the traditional early-stage/seed model on the merits, it may be more accurate to think of it as opening up entrepreneurial finance to businesses that didn’t have much access before. In Equity Crowdfunding for Investors, David Freedman and Matthew Nutting predict that while crowdfunding will eventually attract all types of businesses, early adopters may be limited to certain types, such as consumer products businesses with a devoted fanbase, for-profit businesses supporting a social cause, community-based retailers with investors that have a direct connection to the business, and creative projects such as films, music, and games. Many of these might not quite qualify as a “homerun” to an angel or VC, but could still attract investment for a variety of reasons.

Here are a few questions to ask as you grapple with the question of whether to seek a Reg CF round:

  • How many rounds do you plan on raising in the future? Ideally, your first Reg CF round should be enough to get your project off the ground, and subsequent rounds will also be crowdfunded. I have personally heard one VC state that as of now, he would refuse to invest in a company with a large number of unaccredited investors. That’s not to say that this is a widely-held belief of VC’s or that the industry doesn’t stand to change; but if you anticipate seeking VC funding in the future, a crowdfunding round may be too much of a hindrance in the long term.
  • How competitive is your industry? Are you developing tech that will be the next big thing in virtual reality? The next cure for a heavily-researched disease? If confidentiality, trade secrets or other IP are a major concern, or the industry in which you operate is extremely fast-paced, you may want your investor profile to be as lean as your startup. While drag-along rights (discussed in Part 3) coupled with the founders maintaining control over the company may make receiving stockholder approval for major transactions less of an issue, you’ll want to think about how the disclosures mandated by Reg CF will affect your financing strategy.
  • How big do you plan on getting? Reg CF is overall, less burdensome. But if your company will someday be the size of Facebook (which it will be, of course), then the costs associated with other exemptions may not be a huge concern, all things considered. Of course, if the $1 million cap on Reg CF rounds simply won’t meet your needs, then you should certainly seek alternative exemptions rather than impede your business early on.

You can find Part 1 of this series here.

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