Crowdfunding

Raising Millions With Equity Crowdfunding Will Cost You, But How Much?

Raising Millions With Equity Crowdfunding Will Cost You, But How Much?
Image credit: Brook Ward | Flickr

The recently released Regulation A+ is the first section of the JOBS Act that allows a company to raise capital from the general public. By opening up private company investments to the “crowd,” Regulation A+ promises to be a game changer for how emerging companies are funded. It's the first nationally available form of equity crowdfunding to non-accredited investors.

This will not be as easy as a Kickstarter campaign, however. Raising capital with Regulation A+ will involve more than going online, creating a crowdfunding campaign and watching the money flow in. Regulation A+ involves the sale of equity or debt in your company and is governed by securities laws. This means (cue maniacal laughter) attorneys’ fees, accountants’ fees and compliance costs. Raising $50 million under Regulation A+ is going to require your company to invest money in the process.

The question is: Can Regulation A+ be affordably used by startups and small businesses?

Related: Regulation A+ Is Not the Savior of Cash-Seeking Startups

The first thing to understand is that there are two “tiers” of Regulation A+. Tier 1 allows a company to raise between $1 million and $20 million, and there are no limits on the amount that an individual non-accredited investor can invest. Tier 2 allows a company to raise between $1 million and $50 million, but non-accredited investors can only invest 10 percent of their income or net worth in each tier 2 offering. 

There are different rules and costs associated with each tier. Both tiers will have sizeable costs for SEC compliance and legal fees (damn those lawyers). Tier 1 will have costs for compliance with state securities laws or "blue sky laws." While tier 2 doesn’t require you to comply with the blue sky laws for each state, it will have more onerous accounting, auditing and ongoing SEC reporting requirements.

Both tiers have legal fees and SEC compliance costs, so let’s tackle that ugly subject first. When the law becomes effective on June 19, expect most of the big securities law firms and lawyers to quote ridiculously large bills of more than $100,000 in legal fees and compliance costs.

The reality is, there are competent entrepreneurial-minded lawyers who will charge far less, so shop around, but be sure to check credentials and hire someone who knows the JOBS Act and the Regulation A+ process. Also, as time goes on, expect to see legal fees and compliance costs come down, particularly as innovative companies find ways to automate the compliance process, and as lawyers become more comfortable with the new law.

The two remaining factors are the cost of complying with state blue sky laws (in tier 1) and the cost of two years of audited financial statements (in tier 2).

Related: Tax Trouble? Avoid These 10 Common -- and Costly -- Mistakes.

The tier 1 cost of complying with blue sky laws in all 50 states could run in the tens of thousands of dollars. Some big law firms may even quote six-figure fees. Worse than the cost, the time wasted by having to deal with 50 different state securities regulators could make this process akin to having all of your teeth pulled, one at a time, without Novocain. Because of blue sky compliance, tier 1 only makes sense for a business that is raising money in a contained geographic area and does not need to comply with more than one or two state blue sky laws. Other than that, I believe most companies will use tier 2.

The major expense of tier 2, two years of audited financials records, seems like a deal killer for many small businesses. CPA audit costs of more than $25,000 per year are not uncommon for a revenue producing, young business. One CPA I discussed this with says innovators in the accounting industry will find ways to make these audits work.

“If a startup is new, and does not have significant financial history, there is no reason an audit should be so expensive,” says Craig Denlinger, who left a big six firm to start an accounting business geared towards the JOBS Act market.

Denlinger is right. I have seen quotes from entrepreneurial-minded CPA firms willing to do startup audits for as little as $2,500.

So what will the ultimate cost of Regulation A+ be? As a crowdfunding and JOBS Act attorney who has been fielding Regultaion A+ calls non stop for the past month, I suspect that the minimum a company will need to spend at the onset, with the right lawyer, the right accountant and the right compliance company, will be at least $50,000.

While that seems like a lot for a startup to swallow, how often can a company invest $50,000 into something that will allow them to raise $50 million from the general public? The best news is Regulation A+ allows a company to “test the waters” before spending a ton of money. This means you can approach potential investors and gauge their interest before you spend thousands on putting together all of your filings with the SEC.

Related: Reduce These 9 Startup Risks for a Better Shot at Investor Funding