With the simultaneous drop in the cost of starting up a company and the explosion of online funding platforms, it may seem that you could just tweet out your startup’s URL and have millions of people send enough money to finance you all the way to profitability.
In reality, it isn’t quite as easy as that, but there are now more ways than ever to tap the crowd to fund your new venture. I lay out in detail all the specific steps involved in founding a high-growth company in my new book, The Startup Checklist (Wiley, 2016), but here is a quick overview of the four different types of online startup funding:
Reward-based Crowdfunding
In 1884 the people of France donated the Statue of Liberty to the United States. It was a gift of the heart, but it came with a condition: the United States was required to fund construction of the pedestal on which the statue would stand. When the U.S. Congress and New York State declined to allocate money for the project, newspaper publisher Joseph Pulitzer started a campaign that ultimately raised over $100,000 from more than 120,000 supporters, with 80 percent of the total being raised in sums of less than one dollar. This was the first major crowdfunding campaign. It would take another 120 years and the emergence of the Internet before the concept of raising money from many small donors hit the mainstream.
You’ve probably heard about crowdfunding in connection with some of its best-known online platforms—sites like Kickstarter, IndieGoGo, RocketHub, ArtistShare, and Sellaband—and may have wondered whether this approach could be used to fund startup companies. Under the crowdfunding model, supporters of a project contribute funds to support something they believe in, and receive various levels of rewards or perks in exchange.
The key thing to understand is that in “traditional” online crowdfunding, as it has existed in the United States since 2003, supporters are not in any way, shape or form purchasing ownership in the company or project, nor will they receive any benefit from the success of the project other than receiving the promised product or thank-you gift. Their motivations include pure philanthropy, product pre-purchase, brand sponsorship, making something happen, providing encouragement, getting a special perk, or doing a friend a favor.
While you cannot raise equity funding through these platforms, they can nevertheless be very useful to a startup because they can provide a great vehicle for funded pre-sales of your product, giving you the upfront cash you need to actually develop and produce your Minimum Viable Product. Even better, a successful crowdfunding campaign is an excellent way to prove to investors that you have that elusive thing they are seeking, known as “traction”. You will have demonstrated a market need, a product/market/price fit… and your ability to actually build and ship a product. You will also have formed an instant user base of—hopefully passionate—early adopting customers.
Title II Equity Funding from Accredited Investors
On April 5, 2012, the Jumpstart Our Business Startups Act was signed into law by President Barack Obama. Known as the JOBS Act of 2012, this landmark legislation made it possible for the first time for startups to let everyone know that they are seeking funding. Under Title II of the JOBS Act that went into effect on September 23, 2013, the rules regarding traditional funding from angel investors and others under Regulation D, Rule 506 (b) were changed by adding a new section called 506 (c). Companies can now use online platforms to raise money, soliciting investments from the general public, provided that they take investments only from Accredited Investors (people with over $1 million in assets, not including the value of their home, or with over $200,000 in annual income ($300,000 in annual income if they file jointly with their spouse).
The result of this change was hundreds of websites that purport to connect founders with funders. But since raising money for a startup is hard, there’s a big difference between claiming to provide funding and actually providing it. That said, there are at least a dozen legitimate sites operating under Title II that can be helpful for an entrepreneur during the fundraising process. It is important that you look at them with your eyes open, however, because there is no such thing as a free lunch. In fact, the selectivity of the online platforms is as high as that of traditional angel groups and individual investors.
Only a minuscule percentage of companies are accepted for listing on the platforms in the first place, and not all of them succeed in raising money. Among the reputable Title II platforms are Funders Club, Seed Invest, Angel List, Circle Up, and, of course, Gust.
Reg A+ or “Mini IPO” Fundraising
Another SEC fundraising exemption, Regulation A, had been in place for years and allowed people to invest who were not Accredited Investors. The problem was that it was complex to use, cost hundreds of thousands of dollars for an offering, and allowed a company to raise only $5 million. As a result, only a few dozens of these were done each year. In mid 2015, however, the SEC amended the rules, adding Regulation A+, which now allows companies to raise up to $20 million ($50 million by following some additional rules), from anyone, whether or not they are Accredited Investors. While it will still cost at least $100,000 to file for an offering, Reg A+ can be a potentially useful tool IF your company is past the seed stage, has (or can have) a high public profile, and is willing to be subject to permanent rules about transparency and public filings, including audited financial statements, published capitalization tables and public financial and operating reports.
Non-accredited Investor Crowdfunding Platforms under Title III
As important as Title II online funding platforms have become over the past few years, the last provision of the JOBS Act of 2012 finally goes into effect on May 15, 2016. For the first time, Title III allows the “crowd”—that is, people who are not accredited investors—to invest in private companies. In order not to do away with all the security regulations of the past 80 years, the JOBS Act places strict limits on how much companies can raise this way and how much people will be able to invest in total each year if they are not Accredited Investors.
Under Title III crowdfunding, companies will be able to raise up to $1,000,000 in any 12-month period from non-Accredited Investors using either a FINRA-registered Internet Funding Platform or a broker/dealer. They can also raise money at the same time from other sources, such as angel groups or Title II platforms, under the old rules. Any investor can invest a total (in all rounds of all companies) of between $2,000 and $100,000 in a 12-month period. The 12-month investment limit is based on the greater of annual income or assets: 5 percent of that amount if less than $100,000 (but not less than $2,000), 10 percent if greater than $100,000 (but not more than $100,000). Investors will self-certify their income, assets, and other investments.
How to Raise Money for Your Business Online
So those are the four ways to raise money online to help fund your startup business:
If you have an idea for a sexy consumer product and need to raise just enough to build your first production run, consider reward-based, non-equity crowdfunding.
If you have a business which is close to achieving product-market fit, has demonstrated traction, needs to raise hundreds of thousands of dollars, already has a respected lead investor, and has the potential to be really, really big, consider Title II online fundraising from Accredited Investors.
If your business is already past the seed stage, is relatively well-funded, has brand recognition, needs to raise many millions of dollars, and has access to a base of customers or fans who want to be part of your success, consider a Regulation A+ “mini initial public offering”.
Finally, if you can tell a great story about your business, need to raise less than $1 million, have access to a large group of potential investors, and can live with the trade-off of being “a little bit public”, consider being one of the first companies to try out Title III crowdfunding from non-Accredited Investors.
Whichever you choose (or if you choose traditional funding sources such as bootstrapping, business angels, or venture capital funds), good luck with your startup, and be sure to learn about the other 24 steps to a successful, high-growth startup in The Startup Checklist, available today (only) through a one-day special pre-publication offer for readers of StartupGrind, at checklist.gust.com.
This sponsored piece was brought to you by our partners at Gust.