5 Things Entrepreneurs Need to Know about Equity CrowdfundingBy Elisabeth Seigle on January 21st, 2014 /
As federal legislation remains in the works on Capitol Hill, Governor Rick Snyder has added Michigan to the list of states establishing their own Equity Crowdfunding guidelines via a set of intrastate exemptions outlined in Public Act No. 264.
The new guidelines allow for businesses organized under Michigan law to seek up to $2 million in investment from Michigan investors/purchasers. Non-accredited investors, however, are limited to $10,000 per 12 month period and raises over $1 million will require audited financial statements or reviewed financial statements for the most recent fiscal year prepared by a CPA.
Here are a handful of things every entrepreneur should be aware of when considering Equity Crowdfunding for their next capital raised.
1. There are filing requirements and fees: At least 10 days in advance of the offering, a notice must be filed with the administrator, including a $100 non-refundable filing fee. This notice includes business information and disclosures that will likely cost both time and money. The required information includes:
A copy of the disclosure statements to be provided to prospective investors including:
Description of the issuer (entity type, address, telephone), all owners (over 10%) and officers/members.
Intended use of the proceeds including compensation
Terms and conditions of the securities being offered including the set minimum and maximum amounts for the offering and the valuation implied by the price.
2. The issuer must meet their minimum target: If the capital raise is not equal to or greater than the minimum target offering, the purchasers will receive a return of their funds. So even if no capital changes hands, the financial institution may still collect reasonable fees for its escrow services not to mention legal, audit and marketing costs.
3. Administration and marketing fees may be high: While advertising the issued security is permitted, the cost of effective advertising and the administration costs associated with the equity crowdfunding portals/websites may be quite expensive. Advertising dollars span a wide range, and equity crowdfunding sites may charge upwards of 15% for their services.
4. Smart money adds more than capital to your business: Entrepreneurs must also consider the true value of the capital they are raising. A typical $2M A round, includes an established Venture Capital firm, and all of the advisory and support functions that come with that capital, not the mention access to a network that may be more valuable than the capital itself. Equity Crowdfunding will include a myriad of investor types, and lack the formal relationship typical of a capital raise. For some startups, a hands off investor may be the end game, but the missing value of a well connected VC may be deleterious to future success
5. Legal considerations increase the associated risks: Last but not least, the threat of lawsuits will be a likely concern for those raising significant capital. If inexperienced investors lose money, regardless of their true understanding of the risks associated with the investment, they may claim the issuer, issued the securities under false or fraudulent disclosures or claims. In order to avoid such legal outcomes, it may be wise to bring on legal council from the beginning, adding to the cost of an Equity Crowdfunding round.
For anyone thinking Equity Crowdfunding would be as simple as launching a Kickstarter campaign, a second look at the rules and regulations is highly recommended. A raise of $1 million could cost upwards of $200k* and this would be far from a worst-case scenario.
These financial implications leave one to wonder if the highest potential startups will continue to pursue smart money via traditional investment avenues, leaving inexperienced investors a pool of higher risk options to sift through on Equity Crowdfunding platforms. It may be that Equity Crowdfunding is much better suited to smaller capital raises, for startups that lack access to traditional capital due to niche markets or limited growth potential.
*Assumption: $100 filing fee + $5,000 Audit + $150,000 broker/website/escrow fees (15% of capital raise) + Advertising (+/-$10,000) + Legal support ($10,000)