Recently, I began working as interim CFO with two companies to assist them with fundraising. One of the avenues we’re pursuing is a crowdfunding round — an equity round for one company and a convertible note for the other. While there are certainly some positives to crowdfunding as a concept, unfortunately, the current capabilities of crowdfunding companies are strictly limited.
As with most startups or early stage companies, the two I’m working with need to raise capital to execute their business models. Both are technology-based businesses, which means they’re in the “sweet spot” from crowdfunding as a platform for raising capital. Even so, my direct experience with crowdfunding thus far is that it is a great way to centralize the company’s information so investors can access it. In terms of the crowdfunding companies driving investor traffic to that information, simply put it ain’t gonna happen today.
What Is Crowdfunding?
For those readers/investors who have not had any experience with crowdfunding, here is a short explanation of how it works. The recent change in Securities and Exchange Commission rules has allowed companies to use general advertising to raise capital. Although the SEC did not define exactly what it means by “general advertising,” the rule changes make it clear that companies can now access potential investors through the Internet (among other sources). As a result, Internet-savvy entrepreneurs have established crowdfunding websites through which companies can access investors using a multitude of contact mediums.
There are basically two types of crowdfunding approaches: rewards-based and direct capital raises.
Rewards-based crowdfunding approaches use a wide array of creative methods for raising capital, including donations for charitable entities, coupon purchases for future products, etc.
Direct capital raises involve the sale of equity or debt by the company using the crowdfunding website as the portal to interface with investors.
Most crowdfunding investments, whether through rewards-based or direct capital raises, are small — usually $1,000 or less, and can be as little as $10. The upside to this is that the investor is not risking a large amount of money. The downside for the company is that, if trying to raise a sizable amount, it will take lots of investors to reach the fundraising goal.
The crowdfunding business has made huge strides in a very short time. We’ve seen some dramatic successes in which companies have raised money in record time, surpassing their fundraising targets. However, as I stated previously, at least in my experience, the claims that crowdfunding sites make regarding the numbers of accredited investors actively visiting their sites and investing in deals appear to be grossly overstated. I have no doubt that lots of potential investors visit crowdfunding sites occasionally, but the crowdfunding company’s ability to direct these investors to specific company sites and motivate them to actually invest is, at best, in its infancy.
Keep in mind that crowdfunding companies are not registered broker dealers, which means they’re not licensed to directly solicit investors, and cannot directly participate in fundraising in terms of taking a commission on funds raised. As a result, they cannot directly drive investors to any specific company information for the purpose of generating revenue for the crowdfunding company.
What crowdfunding companies can do is assist the entrepreneurs that list their company information on the crowdfunding site with formatting that information so it looks professional and appealing to investors. They can also provide contact information for potential investors who have indicated an interest in the type of company the entrepreneur has, and can provide media contacts that may be interested in writing about the company, etc.
In my personal experience, all of the information I was provided for investors and for media contacts was readily available on the Internet — free of charge. While it is helpful to have someone provide the information to you, with a little effort one can easily find plenty of contact information.
As things stand today, crowdfunding is a great concept that needs further development. The top crowdfunding sites are a great place to deposit key information about a company looking to raise capital, but it is up to the entrepreneur to pound the pavement looking for investors, and getting the word out about the company.
Any claims made by crowdfunding sites that they can drive investors to a particular company’s information are, again, a gross overstatement of current capabilities. Entrepreneurs should seriously consider their own ability to do the leg work required to identify, contact and interact with investors before choosing to undertake a crowdfunding round.
Additionally, entrepreneurs must have a complete business plan, including a comprehensive financial model, with all current valuation metrics, and a complete presentation deck, before undertaking a crowdfunding round. One of the services I provide for clients is Private Placement Memorandum/business plan writing, financial modeling, presentation writing, etc. If you are an entrepreneur looking to do a capital raise, but do not have your documents completed, do not start a crowdfunding round until you complete this critical step. This information is necessary to build your company’s crowdfunding page and, without it, you will not be able to complete the process.
Crowdfunding personnel are mostly Internet marketing people, and suffer from the same disconnect I’ve found with other Internet marketing people — namely they equate success with website statistics instead of actual sales results. In other words, they believe success is driving traffic on a website, and the entrepreneur looking to raise funds views success as investors writing checks. This is obviously a big problem that must be addressed before the crowdfunding industry can fully realize its potential.
Looking to the Future
Although my current view of crowdfunding is rather negative, based on my recent experiences, I believe crowdfunding represents the future of capital-raising for startups and early stage businesses. Investors will increasingly look to the Internet for investment opportunities. As with everything else, the Internet is simply the best conduit for information flow and will only increase in importance in the future.
Once crowdfunding businesses evolve to the point where they can actually influence investor behavior to drive not just traffic but investors to take direct action (i.e., write checks), crowdfunding will become the go-to platform for capital raises of all types. I envision venture capital and private equity firms increasingly relying on crowdfunding and the Internet to find opportunities (many already use Internet-based sites like GUST.com today).
Yes, the future is very bright indeed, both for the crowdfunding industry, and for entrepreneurs looking to use crowdfunding to raise the capital they need to build businesses. Just don’t expect it to be all that helpful for a few more years.
— Craig Allen, CFA, CFP, CIMA, is president of Allen Wealth Management and founder of Dump That Debt. He has been managing assets for foundations, corporations and high-net worth individuals for more than 20 years and is a Chartered Financial Analyst (CFA charter holder), a Certified Financial Planner (CFP) and holds the Certified Investment Management Analyst (CIMA) certification. He blogs at Finance With Craig Allen and can be contacted at email@example.com or 805.898.1400. Click here to read previous columns or follow him on Twitter: @MPAMCraig. The opinions expressed are his own.