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Aug 31, 2016

Equity Crowdfunding May Not Yet Be Right for Local Social Enterprises

I just finished listening to a webcast by the Angel Capital Association on the new Equity Crowdfunding option that went into effect last May (Regulation CF of Title III: Section 4(a)(6)).  A SEC rule mandated by the Federal Jobs Act, this is the first time companies can approach small investors to invest in their companies.  [Note: I am writing for the casual reader.  If you are serious about pursuing this, consult a lawyer or investment professional.]

Before this, in order for a company to sells shares in the company to individuals, the individual had to have enough income or wealth to be able to “afford” to lose it all.  This “accredited investor” requirement existed because the SEC does not generally regulate private offerings whereas a public offering, open to any investor, has very extensive disclosure and reporting requirements in order to protect the investor from fraud.

This new rule now allows companies to approach most any individual to buy stock in the company.  This is what I took away from the webinar.  Others may disagree.

  • It is not cheap capital to raise.  Intermediaries (usually approved “portals”) take 3% to 6% as a fee and annual shareholder and SEC reporting and accounting fees can easily be $10,000 PER YEAR FOREVER.
  • The remaining restrictions on how a company can solicit and market to investors seem to be so poorly understood that few companies have yet registered to do equity crowdfunding.
  • Almost all of the activity so far has been through a single portal (out of 16 that have been approved), which suggests few have figured out yet how to use this fundraising approach effectively.
  • The few companies that have raised the maximum $1 million that is allowed to be raised each year through equity crowdfunding seem to be companies that already have a wide social media following.
  • Successful companies that gain traction in equity crowdfunding tend to be companies that create social impact or  are women-owned.

This leads me to think that equity crowdfunding is an extension of “reward” crowdfunding.  Reward crowdfunding is what most of us are familiar with:  we give money (through Kickstarter or other platforms) to a company and they send us something inexpensive (a t-shirt, a coupon, potato salad) and that ends the formal relationship.  Companies that are successful in reward crowdfunding know that success is the result of their own efforts to market, reach out, and publicize their product or service.

Equity crowdfunding seems to be worthwhile to those companies that have already mastered reward crowdfunding.  Few local social entrepreneurs have been successful in reward crowdfunding.

So, for now, I think this new channel is not going to be helpful in bringing capital to our social enterprises.

In the meantime, marketing and selling — the task of finding customers and people who want what the company produces — remain the fundamental keys to success.  When a company does them well, then it can try its hand at equity crowdfunding, but I suspect at that stage it may be attractive enough to accredited investors to be able to tap the existing, tested channels for funding a new and growing company.

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Allen Proctor, President & CEO

Center for Social Enterprise Development