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Selling Equity: A High-Stakes Game

Sidestepping the traps of equity fund-raising

The Facebook post reads: "Startup medical device company looking for investors." An eBay ad offers "double-digit growth potential for early investors." And with loans in short supply, you might be tempted to hang an "investors wanted" sign of your own. But be warned: Selling equity is very different from borrowing from Aunt Sally. And it's easy to run afoul of state and federal securities laws, no matter how small the investment.

When Aunt Sally loans you money, she expects to get it back. But when you sell equity, your investors have no recourse if you don't succeed. Their money is just plain gone. That's why the Securities and Exchange Commission and equivalent state agencies want to weigh in. Their prime concern is that investors understand the risks and can afford the hit if the venture doesn't perform as hoped.

While securities regulations offer a number of exemptions that allow small companies to raise equity, you should always seek the advice of a qualified attorney to keep you out of hot water. According to Tonio DeSorrento, an attorney in the Washington, D.C., office of Orrick, Herrington & Sutcliffe LLP, missteps put you at risk of fines, shareholder lawsuits, repayment demands and charges of fraud, and they even undermine your ability to raise money in the future.

Legal cautions notwithstanding, some creative entrepreneurs are bringing 21st technology to the game. Using different approaches, ProFounder and Thrust Fund have set their sights on taking some of the pain out of the process of raising money. Here are their deals.

ProFounder
Dana Mauriello and Jessica Jackley, co-founders of ProFounder in Los Angeles, offer a simple web platform to help you structure, document and market your offer. But unlike traditional equity, their deals are more like debt but with an upside potential. You share a percentage of quarterly revenue, either with your investor or by donating it to a nonprofit organization. This may sound weird, but it's worth noting that ProFounder's advisors include the chairman of LinkedIn, the former CTO of Linden Lab (creator of Second Life) and the CEO of Prosper.com.

An amateur powerlifter with an MBA from Stanford, Mauriello "didn't see why it had to be so hard to raise investment capital in a straightforward and legally compliant way."

Jackley sowed the seeds of her entrepreneurship as co-founder of San Francisco-based Kiva.org. Started in 2005, Kiva was the world's first online micro lending platform. With an average loan size of only $209 and a phenomenal repayment rate of nearly 99 percent, Kiva has transformed the lives of more than 400,00 loan recipients.

Thrust Fund
Launched this year, Thrust Fund has taken an entirely different approach to raising capital. Instead of selling equity in your company, you sell a piece of you--or at least your future earnings.

For example, Appfrica Labs founder Jon Gosier will sell for $300,000 a 3 percent share in his cash-flow-positive tech incubator, which offers jobs, mentoring and seed capital to East African tech entrepreneurs.

Saul Garlick, a Thrust Fund founder, is offering the same deal. At just 17, he founded ThinkImpact, an international nonprofit organization that connects American students to rural villages in Africa to help alleviate poverty through leadership and entrepreneurship. Former President Nelson Mandela has endorsed his work and a former U.S. presidential Cabinet member serves on his board. "To me, it's like selling a share of my future earnings, or a piece of my time," Garlick says, "but nothing more."

Kate Lister is a former banker, small-business investor and veteran entrepreneur. Her books and websites include Finding Money: The Small Business Guide to Financing and Undress For Success: The Naked Truth About Making Money at Home.

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This article was originally published in the December 2010 print edition of Entrepreneur with the headline: High-Stakes Game.

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