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CROWDFUNDING

The Real (and Very High) Cost of Crowdfunding
 

Raising money from hundreds of investors has never been easier--but it comes with higher costs than you might realize.

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Crowdfunding is all the rage. You know, OK'd by Congress, a chance to raise money online from regular folks, a chance for entrepreneurs to obtain capital without the whole "let's go public" mania. A child of the JOBS Act of 2012, it was meant as a way to help smaller companies get the resources they needed to grow and, ultimately, create more jobs.

The playing field is leveled, or at least not so severely tilted in favor of those who already have what they need. But before you start thinking of crowdfunding as a painless way to raise capital, it's best to realize that painless this isn't. Although the JOBS Act was intended to lessen the regulatory burden for startups and younger companies, it isn't going to be race day on the Autobahn.

The Real Costs

Not only are there certain requirements you must fulfill, but there are also costs you may not have figured. The SEC has estimated that a company looking to raise $100,000 or less would need two years of financial statements and its most recent tax return. Raise between $100,000 and $500,000 and a CPA must review the statements. More than $500,000, and you're looking at full audit of your statements.

No matter how much a company raises, the SEC estimates that a company might spend $6,500 on regulatory compliance for the offer (6.5 percent on $100,000 and 1.3 percent on $500,000) and $4,000 for each annual report, an ongoing cost unless your company buys out the investors (4 percent a year at $100,000, or 0.8 percent at $500,000). Then there is the 5 to 15 percent commission from the facilitating website. Suddenly you're paying anywhere from 6.3 percent to almost 22 percent up front and then the yearly annual report fee. On the lower end, that could be pretty expensive money.

Alon Hillel-Tuch, co-founder and chief financial officer at crowdfunding site RocketHub, was quoted by the New York Times last December as saying, "If you're a new business and you have to submit audited financials that you don't have yet, it doesn't make sense." He apparently argued that no business wanting to crowdfund should be held to such a requirement.

Overdub sound of hysterical laughter.

I know entrepreneurs want to protect their babies, but let's get real. The SEC is supposed to oversee equity markets and to protect the interests of investors. How could you possibly expect anyone to invest in a company without seeing financials that were at least reviewed? You're asking people to send in checks without any verification of what the company claims.

If you pay attention to business at all, you'll see many times when companies, uh, reshape the truth, like when LinkedIn's claims of pre-IPO profitability vanished as soon as it filed the S-1 paperwork with the SEC. At the time, I mentioned my new standard for reporting on a company's finances: The company claims to be profitable but would not submit financials to prove that management is not a lying sack of opportunistic dog turds.

Investors have at least as strong an interest in knowing what it really going on before putting their money into a company. So, certainly consider the crowdsourced route. But if so, be very careful, because the liberation could quickly turn to privation.

Last updated: Dec 26, 2013

ERIK SHERMAN's work has appeared in such publications as The Wall Street Journal, The New York Times Magazine, and Fortune. He also blogs for CBS MoneyWatch.
@ErikSherman




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