Crowdfunding – Understanding the Benefits, Rules & Implications

There is inarguable upside to the new crowdfunding rules where new money will be invested in the innovation economy. While this is great for many technology companies, you should consider all your funding options as well as fully understand the crowdfunding rules and regulations and how they apply to your situation. The costs of utilizing this crowdfunding exemption are more extensive than you might think. Are you aware of these costs? Have you considered the benefits your company could miss out on from funding resources? Do you have the right advisor to guide you through the reporting requirements? There are certain effects of the crowdfunding rules that we just don’t know yet and only time will reveal. When determining how to crowdfund, it is important to consider the implications of taking crowdfunding before jumping into it.

Takes Money to Make Money

Raising funding under the crowdfunding exemption will not come cheap. Just like any other financing, there are certain costs that you will incur. For issuers offering more than $100,000, an independent public accountant must either review or audit the financial statements of your company. The deadline for issuance of these financial statements is 120 days after year-end, which puts your engagement in CPA firms’ busiest and therefore most expensive time period.

There are ongoing financial statement reporting requirements, which means the accountant costs may not be a one-time event. Other professional services costs may also increase. The Security and Exchange Commission (SEC) considers any company that utilizes the crowdfunding exemption to be a public business entity. Due to the SEC crowdfunding rules, you very likely will incur increased legal fees and business insurance premiums after being considered a public entity. You should also consider in-house and opportunity costs. The required disclosures and narratives on your company’s financial condition will be time consuming and, at times, complex. Is your finance team qualified? Does your CFO and/or Controller have the capacity to devote time to the various reporting requirements to comply with the crowdfunding exemption?

Investor Implications

In a successful crowdfunding, you can expect to have a number of investors. You may end up with 10-20 investors. Certainly a small enough group to receive personal attention, but also large enough to make demands of all kinds of your finance and management team. What if your crowdfunding results in thousands of investors to answer to? Taking certain corporate actions could require their authorization, and getting the needed signatures could involve substantial efforts. Lastly, you may find that, similar to the product-based crowdfunding (eg. Kickstarter), a significant investment of self-marketing is still needed on your part to attract these investors. Ask yourself, is the $1 million in maximum funding in a given 12 month period worth these costs?

Benefits You May be Giving Up

There are benefits you might lose out on with crowdfunding compared to utilizing other funding sources. If you choose to utilize the crowdfunding exemption, the Private Company Council alternatives for accounting and financial statement presentation cannot be adopted since you are considered a public business entity by the SEC. These alternative accounting principles for goodwill, interest rate swaps, intangible assets and others provide a simplification to small companies with limited financial resources. You’ll be giving these up.

What about the comparisons to venture capital funding? While utilization of the crowdfunding exemption does not prohibit an entity from raising funding from other sources, there is the possibility that venture capital firms may avoid capital structures involving crowdfunding investors. Will you be able to migrate from crowdfunding to more traditional venture capital funding? Relationships with VC firms can be crucial for emerging growth companies that require that next level of funding and the guidance that comes with it. Crowdfunding investors may not add value in the same way that venture capital or angel investors would. They won’t sit on your board, and they might lack the industry contacts professional investors would have.

Reporting Requirements

You should be aware of the reporting requirements under the crowdfunding exemption. However, just as important, is that your team, including your advisors, are competent and have the relevant qualifications to successfully meet the reporting requirements.

The offering documents should include management prepared narratives on the company’s financial condition. These narratives are very similar to what is required as part of the Form 10-K and is typically subject to critique by legal counsel and auditors. Evaluate your finance team, legal counsel, and accountant. Does your financial executive have prior SEC reporting experience? Does your legal counsel have a SEC reporting practice? Do you know what needs you have for an independent CPA? While any independent CPA can perform the audit or review, your financial statements and other required data for disclosure will be publicly available. You should consider whether you are comfortable with a firm with less SEC experience handle your audit when under the scrutiny of the SEC and in such a public arena.

Future Remains Hazy

As you consider whether you will utilize the crowdfunding exemption, it is important that you understand the implications and requirements. There will be additional expectations by regulators, additional funds expended, and additional personnel or skills to meet them. If you should decide to partake in crowdfunding as another funding source for your company, you know where you need to start asking yourself these questions. While we may not yet know how the VC community views crowdfunding, you will at least know where you stand on the option.