Crowdfunding seems to me to be a very startup-friendly way to raise money for your company. After all, in most cases, crowdfunding enables a startup to raise money from individual investors who are eager to receive an early version of your company's product. And these investors write small checks -- thus limiting their ability to control how you run the company.
In the past, crowdfunding has been used only on a limited basis because startups find the requirements onerous. For example, crowdfunding rules set up in 2012 by Congress "require many companies using crowdfunding to provide investors with audited financial statements, which increases the cost of selling stock or debt," according to the Wall Street Journal.
On March 4, the Securities and Exchange Commission (SEC) proposed to allow startups to increase how much money they can raise from crowdfunding from $1 million to $5 million. The SEC's proposal -- which is open for public comment for 60 days -- also raises the amount an individual investor could contribute to crowdfunded deals from whichever is higher: 10 percent of their annual income or net worth.
The SEC's new proposal also lets companies raise up to $75 million--$25 million more than the current amount--through a mini public offering. Through this so-called Regulation A+ offering, startups could bypass the regulation required for an IPO, while being subject to "stricter disclosure requirements than crowdfunding," reported the Journal.
The recent crowdfunding results have been very unimpressive. A 2019 SEC staff report found that between 2016 and 2018, 519 completed crowdfunding deals raised an average of $107,367, with a median investor contribution of $260, noted the Journal.
In my mind, these low numbers are a sign that only a small number of small investors are parting with their money for a piece of relatively weak startups."Many of those companies have performed poorly, and stock exchanges have shied away from listing the shares," wrote the Journal.
If the SEC proposal goes into effect, should you raise $5 million through crowdfunding? I believe you should only do so if you can make your investors better off.
Here are four ways to make sure your startup satisfies the more stringent requirements I alluded to -- and thus boost the odds of giving your investors an attractive return.
1. Sell a product that solves a painful problem for potential customers.
To start off, your product should be solving the right problem. You'll know that if you have listened to 100 potential customers and found commonly shared pain that no product currently available can relieve. If you have a clear vision for a product that will satisfy this unmet need and the talent required to build it, you have passed the first test.
2. Target a large, growing market.
The second test of a high quality startup is that it targets a market that's large enough to support a significant company. More specifically, since investors typically assume that it will take $100 million in revenue to go public and that your company will at most be able to win 10 percent of the market, a big enough market should host at least $1 billion in revenue.
3. Build an outstanding leadership team.
The next test is whether you've assembled an outstanding leadership team. Such a team includes a CEO who is an industry thought-leader. You want someone who is smart, learns quickly, has a track record of winning, and can hire and motivate excellent leaders for key roles such as product development, sales, marketing, and finance.
4. Offer customers value that's better than your competitors.
The final test is whether your company knows enough about the market to design, build, sell, and service a product that provides customers with more benefits for the money than do competing products.
If you can satisfy these four tests, you have a great chance of making your crowdfunding investors better off -- and for that reason you should seek to raise $5 million from them.