An Alternative Startup Fundraising Strategy -- Equity Crowdfunding
FUNDRAISING STRATEGY FOR EARLY-STAGE STARTUPS (№3 OF SERIES)
Crowdfunding has not yet become a norm when startups do equity fundraising. One main reason is that venture capital has emerged and has become a mainstream approach since the launch of Kleiner Perkins and Sequoia Capital in the 1970s. Access to investing in private companies was essentially not feasible for most non-accredited investors until the implementation of Jumpstart Our Business Startups Act (“JOBS Act”) several years ago.
1. What Is Equity Crowdfunding?
Crowdfunding literally can be interpreted as funding from the crowd. Since the JOBS Act, equity crowdfunding has been evolving and has become an option for startups to get capital instead of VCs. In narrow terms, equity crowdfunding refers to fundraising by companies according to Regulation Crowdfunding (“Regulation CF”). Such crowdfunding can only be made through an online platform operated by an intermediary (“Intermediary”), which is either a registered broker-dealer or a registered funding portal. However, depending on the Intermediaries’ business, each Intermediary may also facilitate equity funding made according to general solicitation rules (“Rule 506(c)”), private placement rules (“Rule 506(b)”), or exception rules from registration for public offering (“Regulation A+”). Therefore, in a broader sense, when people say equity crowdfunding, it may refer to the funding facilitated by an Intermediary based on Regulation CF, Rule 506(b), Rule 506(c), and/or Regulation A+.
Below is a good summary provided by the Intermediary SeedInvest about the aforementioned 4 types of offerings.
2. Why Crowdfunding is Special?
VC approach (including some angel investors) requires person-to-person interaction and deal-making. Crowdfunding is done through an online Intermediary. Startups don’t need to be directly connected with investors. The Intermediaries will have an investor pool, probably including both accredited and non-accredited investors. Intermediaries will discuss with startups on the fundraising strategy and decide to choose one or more funding sources.
Users Can Be Investors
One great benefit of crowdfunding is turning the users who understand the value of the company and products into investors. This could be very rewarding for consumer-facing startups. A very recent example of this is the independent tech media HackerNoon. Before HackerNoon launched the crowdfunding campaign on the Intermediary StartEngine earlier this year, HackerNoon already had a solid and loyal community that consisted of 7,000+ writers and 200,000+ daily readers. According to HackerNoon’s CEO David Smooke, HackerNoon’s existing community has contributed 85% of visitors to the crowdfunding campaign. They successfully raised $1.07 million from 1,199 investors.
Investors Can Be Partners
This is related to the last point. Investors are aligned with the company. If they are users, they could be more loyal and caring. They have a strong sense of ownership and will be more supportive to grow the company. Investors who invest more will also likely become partners who may introduce a variety of resources to the company. They are not involved like other VCs at the board-seat level, but they are personally engaging.
3. How to Do Crowdfunding
Crowdfunding is relatively new and it may be even more overwhelming compared with fundraising with VCs. As mentioned, crowdfunding has to be done through the Intermediaries. They work similarly to investment banks for IPOs which provide resources and guide the companies through the whole process.
Step 1: Deciding Whether Equity Crowdfunding Should be Considered
Not every company is suited for equity crowdfunding. First of all, some founders don’t like managing many shareholders. And some companies may not have met the criteria set by the Intermediaries or even the criteria required by the laws and regulations. However, if founders feel equity crowdfunding could be an alternative for whatever reason, they should talk to Intermediaries to find out more information and make further decisions based on those conversations.
Step 2: Doing Searches and Compiling An Intermediary List
Companies should start by finding the right Intermediary for the crowdfunding campaign. There are 3,000+ organizations categorized as “crowdfunding” on Crunchbase. A smart way to start is by either seeking introductions from someone who has succeeded in an equity crowdfunding or searching for successful cases that share similar demographics in terms of investors' preferences. Check the Intermediaries’ websites and learn details about their successful cases, how they manage the facilitation, the services they offer, etc. Founders should have a shortlist of intermediaries they want to move forward with.
Step 3: Asking Questions with Intermediaries and Making Decisions
Intermediaries have different business models and focus. The interaction with Intermediaries is very necessary for founders to learn and assess whether the Intermediary is a good fit or even whether an equity crowdfunding is a good option. I summarized a list of topics for founders to communicate with Intermediaries:
4. The Take-away
Equity crowdfunding is one form of crowdfunding. There is crowdfunding in exchange for services, products, or even tokens. For example, Oculus VR (acquired by Facebook) did its product crowdfunding campaign on Kickstarter in 2012. St. Regis Aspen Resort did a security token fundraising with help from Indiegogo in 2018.
Crowdfunding could essentially build up a distributive ecosystem for the startup. It applies the crowd’s capital and even wisdom and resources. But it also requires lots of experience and legal work, as well as professional investors’ communication. It doesn’t necessarily fit for every startup but it could be an option.
This article should not be construed as or relied upon in any manner as financing, investment, legal, tax, or other advice. Readers should consult your own advisors as to legal, business, tax, and other related matters concerning any financing or investment activities.