MONEY

Crowdfunding? Rule No. 1: Bare Your Soul

Long-awaited SEC rules clarify how entrepreneurs will one day raise money on crowdfunding portals. The process starts with disclosure. Lots of it.
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Louis Day hopes to raise $2 million to fund a nationwide expansion of NS Capital, his investment advisory firm. But Day, who founded the business in Stamford, Connecticut, in 2008, doesn't plan to hit up banks, VCs, or angels. He plans to launch a crowdfunding campaign.

In what must be the longest anticipated development in entrepreneurial funding since the invention of paper currency, the Securities and Exchange Commission finally proposed a set of rules that will allow private companies to offer and sell securities through online crowdfunding portals. It's all part of the slow rollout of the JOBS Act signed by President Obama almost two years ago. The law will allow businesses to raise up to $1 million a year from unaccredited backers (defined as people with a net worth of less than $1 million--excluding the value of their homes--or annual income of less than $200,000). The rules, which the SEC approved unanimously, have been in a 90-day comment period ending this month. The final regulations could take effect by this summer.

Day, who has raised $600,000 from friends and family, is gearing up for his campaign. But equity crowdfunding will be a lot tougher than soliciting donations on Kickstarter. Here are four things to consider before jumping in.

You Have to Choose the Right Platform

There will be a variety of SEC-approved crowdfunding portals, and to raise funding this way, you'll need to use one of them. The assortment of offerings isn't laid out yet. One thing's sure: There will be a few that emerge as the best or most reliable, so it might be best to not jump the gun here; hold off until you're sure you are making the right choice. Several crowdfunding portals, including SeedInvest and CircleUp, already help companies sell shares to accredited investors. The sites, which are ramping up to support crowdfunding from unaccredited investors, use an in-depth application process and software that vets investors to ensure they meet SEC requirements.

You'll Have to Share (a Lot More Than You're Used To)

If you're fundraising in the open, you're truly in the open. Equity crowdfunding will require you to make plenty of disclosures to the SEC and investors, including financial statements that, depending on the amount you offer and sell during a 12-month period, must be audited or accompanied by a copy of your company's tax returns. You must disclose information about company officers, directors, and anyone who owns 20 percent or more of your business. You must also explain what you plan to do with the funds you raise. The good news? Many equity crowdfunding platforms offer tools that make it easier to share information with investors. Day is preparing by adding an explanatory video and other information about the business to its website.

You Have to Know the Limits

Because companies can raise up to only $1 million a year through crowdfunding, it is more useful to a mom-and-pop shop looking for a rev of its engine than it is for the next Palantir or Amazon. Another limitation is that investors cannot sell their shares for a year--so both they, and your company, are locked in. Also, keep in mind that you must establish a company valuation to set a share price. That can be tricky for early-stage companies. CircleUp helps by providing data on comparable businesses. If your company has a longer record, consider hashing out a valuation with VCs or angels, who might be interested in investing later.

You Have to Deliver

Think about how you will deliver returns to investors. If you plan to sell your company within a certain time frame, make that clear up front. If you have no plans to sell, consider establishing a secondary market within your company that would allow investors to sell shares to other shareholders. "Entrepreneurs have a huge responsibility when they take on investors," says Sherwood Neiss, principal at Crowdfund Capital Advisors, a consulting firm that helped craft the crowdfunding legislation. "You have to do what you say you are going to do." When dealing with a crowd of unsavvy investors, that responsibility is even greater.

IMAGE: Frederica Bordoni
From the February 2014 issue of Inc. magazine

DARREN DAHL

Darren Dahl is a contributing editor at Inc. Magazine, which he has written for since 2004. He also works as a collaborative writer and editor and has partnered with several high-profile authors. Dahl lives in Asheville, NC.




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