Now that President Obama has signed the Jumpstart Our Business Startups (JOBS) Act into law, the number of entrepreneurs seeking to finance their businesses through crowdfunding is likely to jump.
Crowdfunding can be a wonderful way to finance your company while you build it into something that more traditional angel investors or venture capitalists would be interested in investing in. Or it could be all of the money you need to raise if you’re not starting a high growth/rapid expansion company but simply need the initial launch costs of a more traditional and stable business covered. Not only does crowdfunding open up new opportunities for entrepreneurs that are unable (or don’t want) to raise funds through traditional loans or equity investments, it also serves as a great initial litmus test of your idea.
Clearly, you’ll need to assess if crowdfunding is the way to go for you and your new company versus bootstrapping, getting a loan, or seeking VC/angel investment. Think about how much money you need, what you’re willing to give up in exchange for that money, and what your future goals and growth trajectory are to determine what funding source is the best fit.* Then, if you’ve decided that crowdfunding is the way to go, make sure that you keep the following items in mind before moving forward:
- Be careful about ownership rights and control. If you decide you’re willing to give up small pieces of equity to numerous crowdfunding investors in exchange for the cash your company needs, that’s fine. However, you need to ensure that you’re not giving up control to hundreds or thousands of others. Too many cooks in the kitchen will kill your company because nothing will ever get done. You don’t want to get stuck “herding cats” and never being able to move forward with a strategy because you can’t get enough of your investors to agree.
- Be aware of your liability. The majority of the criticism of the new law is that it eliminates investor protections and will potentially allow scammers to take advantage of inexperienced investors. In an attempt to mitigate this risk, those seeking funding will be required to provide financial statements to would-be investors, but these financial statements do not need to be audited. Setting aside the fact that this stipulation actually does almost nothing to protect investors, it does create the need for honest entrepreneurs to be extra careful about how they present this information. If you’re not a whiz at accounting, ask for help before you present financial information to potential investors. If you’ve made mistakes or miscalculations that affect how an investor would evaluate your company, you could be on the hook for fraud down the road if the investor becomes disgruntled and claims that it was your incorrect information that led him/her to invest.
- Plan ahead for extra investor communications. Even if you’ve made sure that your investors don’t have official control over what your company can and cannot do, many of them are going to want to know what’s going on and to give you their opinions. Be sure that you’ve budgeted enough time (and emotional patience) to be able to handle this level of interaction. If you have 100 investors who want to call, email, and meet with you, it’s going to take a lot more time than if you have 2. You need to plan ahead to have a strategy for streamlining communications and making sure that your investors feel heard, informed, and included while not allowing them to suck too much of your time away from running your business.
Crowdfunding can be a great way to get the capital you need for your business. However, with more investors you’re likely to get a few more headaches, so its important to pursue a crowdfunding strategy with your eyes open so that you’re able to keep your company’s growth on track.
*I’ve tweeted in the past about some issues that crowdfunding can cause when you get to future funding rounds so make sure you are aware of all of the pros and cons of every type of financing you’re considering so that you make the right decision.