6 To-Dos to Prepare for Equity-Based Crowdfunding

Beginning next year, your startup venture will be free to raise capital from Mom and Pop investors. Are you ready?
President and CFO, CFOwise
June 25, 2012

In April 2012, the historic JOBS Act was signed into law, legalizing a completely new class of equity and opening up an opportunity for entrepreneurs and small- to medium-sized businesses to raise capital from unaccredited investors.

Prior to this law, privately held companies were only allowed to sell stock in their companies to accredited investors, meaning those with annual incomes of more than $200,000 or a net worth in excess of $1,000,000, excluding personal residence. Some experts estimate the passage of the JOBS Act could unleash unaccredited investors, or the gross majority of the population in the U.S., to direct as much as $300 billion from their savings and investments into crowdfunded equities.

The law authorizes equity-crowdfunding effective January 1, 2013. It also calls for the U.S. Securities and Exchange Commission to clarify and issue compliance directives for all who wish participate in this form of crowdfunding. While we wait to see exactly what the SEC will do, there are six steps that business owners can take today to prepare to sell ownership in their companies through crowdfunding.

1. Build and deepen your network.

Experts who study donation and rewards-based platforms, like Kickstarter and RocketHub, say that crowdfunding projects only work when at least the first 25-30 percent of the targeted goal comes from those within the fundraiser’s first degree network. These relationships can be built both face-to-face and online through social media. However, just having a lot of Twitter followers will not get it done. You need as much depth in your network, meaning trust-based relationships, as you have breadth. After all, you’re asking this group to believe in your ability to take their money, use it to build a successful business and ultimately, share a harvest that represents an acceptable rate of return.

2. Prepare for transparency.

Part of the SEC's stated mission is to protect investors. Their major concern with crowdfunding is keeping fraudulent projects from stealing money from those who trust and want to buy into the vision of the entrepreneur. Yet the nature of crowdfunding already safeguards against much of the fraud.

First, those raising money and all other officers, directors and owners of more than 20 percent of the company will be subjected to a fraud and background check. Second, crowds are usually pretty good at vetting a fake. Third, the platforms will allow for open dialogue between prospective investors and the entrepreneur. If a question goes unanswered for more than a day, or if the answer provided is not adequate in the eyes of the crowd, the crowd will take their money elsewhere.

3. Dial in your pitch.

Entrepreneurs will get a small amount of attention from each prospective investor. The right combination of video, photos and text will be needed to tell your story convincingly. After all, investors will likely have many companies from which to choose, and the JOBS Act limits the amount unaccredited investors can put into equity-crowdfunding each year. Crowdfunding experts consistently associate the most successful campaigns with an ability to gain an emotional connection between the funders and the products or services offered by the entrepreneur. Your story needs to be compelling and brief, which will take time and careful preparation to master.

4. Have a plan.

Investors want to know what the entrepreneur will do with the money raised through crowdfunding. What is the plan for the business? How will the new capital empower the entrepreneur to break through previously impenetrable barriers and reach success?

5. Understand the legal and financial ramifications.

Equity-crowdfunding isn’t even three months old, and it’s not legal for another six months. There are still many unanswered questions about the rights and terms associated with crowdfunded stock and how it will affect the potential for future rounds of financing. Learn as much as you can and make sure your legal and financial advisors are familiar enough with this new class of equity to give you good advice.

6. Keep building and strengthening your company.

Determining the value of your company will be one of the trickiest parts of equity-crowdfunding. If you value your company too high, then the crowd will likely be turned off by your offer. If you sell shares in your company for too little, then you’re giving away more than you should, diluting your ownership in your company. By doing everything you can to improve and grow your company before you crowdfund, you’ll be able to justify a higher valuation, primarily because you can reduce the risk to investors the more you’ve proven that customers will pay you for your product or service and you can build a profitable enterprise.

Ken Kaufman is the President & CFO of Aribex®, an innovator of handheld devices disrupting medical imaging globally. As an award-winning executive with almost two decades of experience starting, growing, leading, and financing dozens of organizations, Ken is a highly sought-after speaker and author of the best-seller, Impact Your Business.

Photo credit: Photodic/Thinkstock

President and CFO, CFOwise