Crowdfunding: Four things you need to know

Crowdfunding: Four things you need to knowGetting funding to start or grow a small business used to be difficult and frustrating. Fortunately for small businesses, recently there has been a significant change in the landscape – including a new law enacted in May – making it much easier for businesses to acquire cash.

The changes are around Crowdfunding.  As the word implies, Crowdfunding is getting the ‘crowd’ to fund your business.  This is analogous to having all your Facebook friends kick in money to get your business started or grow it.  But Crowdfunding uses a much larger sphere than just your connected friends—essentially anyone.

Crowdfunding in a broad sense has been around for years.  Due to SEC security laws, it previously was very expensive, and in many cases prohibitive for small companies to raise cash via equity investment.   Because of these restrictive laws, early Crowdfunding depended upon a ‘pre-sale’ model.  You pre-sold your product using early, unearned revenue as the seed capital, often on websites such as Kickstarter and Indiegogo.

This model was not very effective for service-based businesses, however.  Even for product-based companies, it didn’t pay back the investor or provide an ownership stake in the company.  Naturally, those drawbacks limited interest among potential investors and the amount of money available. The J.O.B.S. (Jumpstart Our Business Startup) Act in 2012 broadened the ability to raise money, but kept some prohibitive restrictions.

But that’s in the past.  This May, there was a huge change in the law and the largest obstacle fell.  No longer must an investor be “accredited.”  Now anyone can be an investor in these early companies.

This development will totally change the capital-raising landscape for small businesses.  While the previous options are still available, including pre-sales and borrowing money, these new rules open up the possibilities.

Intrigued about the possibility of seeking investors for your small business?  Here are three things to pay close attention to:

Investor facing financials.  A good set of financials for the business has always been necessary.  But here the focus is not so much on paying back a loan, but a set of financials structured so that the business can grow and show the investor a solid return.

Deal Structure.   Everything is possible.  What type of equity will you offer in your company; straight equity, common vs. preferred stock, stock warrants, or any of a number of variations?   Having an equity investor is not the same as a having a simple bank loan with repayment terms.

Governance.  This is just a fancy way of saying you will be managed by your investors and will likewise will need to manage them.  There will be periodic investor updates with detailed discussions on performance and future plans.

Government Compliance:  The government has instituted some rules to insure this new Crowdfunding is properly followed.  The onus of adherence to the rules falls on the entrepreneur not the investor.  So be aware of new record keeping requirements.

Crowdfunding, while significantly increasing your business’s financing options, also makes having the right management team for your business much more imperative.  Your company’s financial health should never be a do-it-yourself project in which you go it alone. Even if your investors are friends, these are not waters you want to go into unprepared.

Dan Gotte is a partner in Fuse Financial Partners, Charlotte-based  financial services firm. He has been an instructor in CPCC Small Business center for about seven years presenting on funding, financial and accounting topics.


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