What is equity crowdfunding?
On May 16, 2016, Title III of the Jumpstart Our Business Startups (“JOBS”) Act of 2012 (Regulation CF) (“Regulation Crowdfunding”) came into effect. This allows for a much broader range of investors to invest in non-public issuers in exchange for equity, as long as the issuer is offering the securities through an intermediary registered with the “SEC”, which can be a broker-dealer or a FINRA-regulated funding portal. A list of FINRA-regulated funding portals is here. As of the date of this blog, there are 46 FINRA-regulated funding portals.
Regulation Crowdfunding is a very attractive exemption from registration for small businesses looking to raise capital because it broadens a company’s investor base and allows them to raise enough money (up to $1,070,000 over a 12-month period) to develop a concept or implement measures to increase business operations.
What is the secret to a successful crowdfunding offering?
The first SEC-NYU Dialogue on securities crowdfunding was held on February 28, 2017 (less than a year after Regulation Crowdfunding came into effect) at the SEC headquarters in Washington, DC. The dialogue brought together practitioners, regulators, and academics to learn, engage, and discuss the state of the new U.S. crowdfunding industry and exchange ideas on issues related to investor protection and capital formation. MF Fire was one of the first companies to conduct an equity crowdfunding and, during the symposium, MF Fire’s CEO, Paul Laporte, discussed his opinion on the factors that contribute to a successful equity crowdfunding offering which are summarized and discussed below.
Strong Social Media Network
The first factor that Mr. Laporte believed would lead to a successful equity crowdfunding offering is having a strong social media network. Regulation Crowdfunding requires all issuers to conduct their crowdfunding offerings through an intermediary registered with the SEC. During the symposium, it was stated that a very select amount of funding portals have acted as intermediaries for a majority of the money raised pursuant to Regulation Crowdfunding. Although each intermediary is responsible to market its own platform, an issuer conducting an offering pursuant to Regulation Crowdfunding should not rely on the funding portal’s marketing alone and should already have done its own marketing of its brand and products. One of the most effective ways to market is through social media. Companies who already have a large and loyal social media following before they commence their crowdfunding offering have a larger chance of success than their counterparts. Management for companies planning on conducting a crowdfunding offering who have not done so should consult with a marketing expert in order to ensure their social media following is large enough to contribute to a successful crowdfunding offering.
Frequent Communication with Crowdfunding Community
The second factor that Mr. Laporte believed would lead to a successful equity crowdfunding offering is frequent communication with the crowdfunding community. As with any securities offering where outside investors who are not insiders of the company are brought in as equity holders, happy investors are a key to a successful equity crowdfunding offering and to future offerings. Many small businesses believe that investors are only happy when they are getting a return on their investment and, although that may be true in many cases, most investors who invest in startup companies are aware of the risks that they may lose part of or all of their investment. Not all investments are guaranteed successes so, if companies cannot guarantee a return for each investor, they can take measures to make sure that each investor is informed about the company. Although companies who conduct equity crowdfunding offerings are subject to ongoing reporting requirements with the SEC, management can provide additional disclosure through a monthly or quarterly newsletter. Creating a transparent environment for crowdfunding investors can ensure a successful offering.
Efforts to Demonstrate Legitimacy
The third factor that Mr. Laporte believed would lead to a successful equity crowdfunding offering is efforts by the issuer to demonstrate legitimacy. It is fairly well-known that much of the investor fraud that occurs in the marketplace happens in microcap stocks. Due to this and the nature of companies engaging in equity crowdfunding offerings, many investors who would otherwise invest may be leery that the companies seeking investors are not legitimate. The disclosure required by Regulation Crowdfunding, when compared to a registered, public offering with the SEC, is scaled. One way issuers in crowdfunding offerings can provide legitimacy to investors is through providing audited financial statements to investors; however, audited financial statements are not required unless an issuer is seeking to raise more than $500,000. Crowdfunding issuers must effectively tell their story while providing backup documentation to support the legitimacy of their company so investors feel safe investing in the offering.
The decision whether to commence a crowdfunding offering, including the preparation of required disclosures and securities compliance, can be complicated and difficult. Business Legal Advisors, LLC has over seven years of experience assisting companies with private offerings from preparing for the private offering to the completion of a successful offering.