Ready To Launch

What Entrepreneurs Need to Know About Crowd Finance

What Entrepreneurs Need to Know About Crowd Finance
Image credit: Shutterstock.com
  • ---Shares
Reader Resource

Get the working capital your business needs–learn more about Entrepreneur Lending, powered by CAN Capital »

Could Elio Motors, a maker of a quirky three-wheeled car, be the model for the future of corporate finance?

The Phoenix startup has created a sexy, high-mileage, low-cost, car, which–yes–will sport three wheels. More importantly, perhaps, last month it became the first crowd funded company to be traded publicly, eventually rising to a $1 billion-plus valuation in the over-the-counter market.

Not bad considering that founder Paul Elio started the company with the help of $17 million from 6,600 investors on a crowdfunding platform.

The funding was enabled by the 2012 JOBS Act, created during the Great Recession to help capital-starved entrepreneurs. Under various regulations that have been rolled out under that legislation, crowdfunding can be considered for many types of fund raises, ranging from the tens of thousands to the tens of millions of dollars.

Of course, crowdfunding has it roots in the fund-my-movie, I’ll-mail-you-a-t-shirt raises, a la Kickstarter or Indiegogo. But it has evolved way beyond that into something much more disruptive and powerful: honest-to-god crowd finance.

The next stage of the 2012 JOBS Act will take effect May 16. This latest wave, known as Reg CF, will allow small private companies to crowdfund less than $1 million from non-accredited investors in exchange for equity. In other words, this will be the first time that non-millionaires will have a ready mechanism to buy stakes in startups.

If you have a small business-sized idea – an iPhone app, perhaps – and need only a little capital to start, now you can raise money -- $250,000 to $350,000 would be a reasonable goal from mom-and-pop investors in exchange for pre-IPO shares of the business.

Millionaire investors have had already had investing access to equity crowdfunding for a little over two years, and can be tapped for larger amounts if you have an Elio Motors-sized idea.

Crowdfunding rules also allow entrepreneurs to offer debt, which in fields such as real estate can be more attractive to investors, who can see interest and principal payments as a project gets off the ground.

Either way, for many smaller entrepreneurs, the process likely will be more efficient and less expensive than other methods of capital-raising, such as a bank loan, credit cards, or a desperate search for an angel or two. (Institutional venture capital and private equity are often out of the question at small enterprise levels.)

Related: The SEC Just Approved Rules Opening Up Equity Crowdfunding to the General Public In a 3-1 Vote

Rules of the Raise.

There are some rules of the highway, of course. For example, the SEC limits the amount individuals can invest to 5 percent of their annual income if earning less than $100,000 a year and 10 percent for those making more than $100,000. The crowd funding also must be done via FINRA-registered platforms or broker-dealers.

So, what should small entrepreneurs know before looking for investors on a crowd finance site?  How can they make the best use out of this novel platform? Some quick tips for those considering equity crowdfunding:

Know how much money you hope to raise and how it will be used. It will raise investors’ eyebrows if the funding you raise will pay for a fat salary for yourself and your cohorts. The planned use for the money will be an obvious make-or-break element for investors looking at your proposal.

Related: The JOBS Act: What You Need To Know

Know your target audience.

Is it millennials? Boomers? Techies? A small, obscure niche? This matters because some demographics are more open to crowdfunding as a concept. If you are positioning a company that has a societal benefit, for instance, you might be a winner with millennials.

Be thoughtful in how you structure this round of capital raising. Your capital structure matters. For instance, what does your bank or your other lenders, if you have them, view this offering? Your other shareholders? Do your corporate by-laws allow for this type of fundraising?

Other things to consider: You need to have time for investor relations and your controller or CFO needs to have enough background to manage a large number of investors.

Finally, crowdfunded equity stakes can be fairly illiquid. Venture exchanges to help facilitate this are coming but are still ways away. Illiquid shareholders can get cranky over time and create headaches for founders.

Related: What the U.S. Can Learn From the Netherlands About Equity Crowdfunding

Social skills count.

Once you are set up on a crowd finance platform, it helps to have a solid social media presence – Twitter, LinkedIn and  Facebook at a minimum. You can knit together networks there that will help you find investors. Family and friends on social media or even offline might find crowd financing a safer and more formally documented way to invest in your business than just writing a check to you and hoping things work out.

If you have sales already – and hopefully, you do – encourage your customers to become small shareholders. After they invest, encourage all these groups – social media contacts, customers, plus family and friends – to become evangelists for your firm. After all, they are now owners.

Lastly, expect to be vetted by the platforms. Regulators hope the legal liability they have placed on them will limit fraud and other shenanigans, always a high concern with small and perhaps unsophisticated investors. Bottom line: This new form of micro-crowd financing will allow many very small, early-stage startups to grow and blossom more easily than ever before.

Perhaps even grow into a billion-dollar company like Elio.