(Note: This is a monthly startup series authored by Charlotte investor Greg Brown, the administrator of the Charlotte Angel Fund, where he will discuss the current batch of startups presenting to the fund’s membership as well as topics that may be of interest to those who care about Charlotte’s entrepreneurial community.)
The concept of crowdfunding for companies has greatly increased in popularity in recent years. Companies that are developing their financing plans need to understand the different types of crowdfunding and the impact that each method may have on their ability to raise capital in the future.
What is crowdfunding?
Crowdfunding is a method of raising capital for a project or company from a large number of people, typically via the Internet. It can be applied to for-profit ventures, creative projects, social causes, or initiatives such as collecting donations to cover someone’s medical expenses. GoFundMe, Kickstarter, and AngelList are each examples of crowdfunding sites, each serving very different purposes.
There are three primary ways that a company can raise capital via crowdfunding.
(1) Pre-selling product
Sites such as Indiegogo and Kickstarter can be used to take pre-orders for a company’s products. It is often used to raise the capital required to produce the afirst units of a product, including tooling or other costs of manufacturing setup.
This type of crowdfunding is a very good way to test the market for a consumer product idea. If the concept generates enough enthusiasm to get people to pay in advance of the product being available for delivery, the chances are good that the product is in fact addressing a market need.
Angel and venture capital investors will look at a successful crowdfunding campaign of this type as a positive signal, thus it will enhance the company’s ability to raise equity capital in the future.
(2) Selling equity to accredited investors
The concept of crowdfunding can also be used to sell equity ownership to what are known as accredited investors. The term accredited investor means a person or entity that is free to invest in non-publicly traded stock via meeting the government’s income or net worth criteria. Right or wrong, the government views these people as having the level of financial sophistication required to understand and take the risk associated with illiquid investments.
Sites such as AngelList and Malartu are used by early stage companies to raise capital from accredited investors. A startup or a fund might decide to use such a site in order to increase the audience that is exposed to their investment offering. An example of this is the QC Fintech accelerator program, which has raised funds for its program via the Malartu platform.
Having raised equity capital via an equity crowdfunding campaign that is limited to accredited investors will not in any way impair the company’s ability to raise future funds from angel or venture capital investors.
(3) Selling equity to non-accredited investors
This is where things start to get complicated. Recent legislative changes allow companies to raise a limited amount of capital from non-accredited investors. There are also restrictions on the total amount that a non-accredited investor may invest in any one year. Such offerings must be conducted via an online crowdfunding platform.
The idealist in me likes the idea of people being able to do what they please with their money. The realist in me foresees problems for all involved.
Angel and venture capital investors pay a lot of attention to who the other shareholders are when they make investments. This is important because an upset shareholder can create a lot of headaches for the company and anyone involved with it. They want to know that the other investors have reasonable expectations, and understand the risk that they took when making their investment.
Because non-accredited investors are likely to have very little experience with such investments, and little tolerance for the financial risk associated with them, investors will be extremely hesitant to provide subsequent funding to a company that raises capital via this method. I do not envision that Charlotte Angel Fund would ever fund such a company.
Startups need to be very mindful of the impact that raising capital via this method will have on their ability to obtain future funding.
Who presented to Charlotte Angel Fund in November?
Our lineup of presenters this month was:
Felix Gray is an eyewear brand based around eye health in the digital age. This New York-based company offers eyewear with specialized lenses to filter blue light and eliminate computer glare.
This Charlotte-based company has developed a software platform where security managers of federal contractors with security clearance can access and stay compliance with required regulations. It aggregates regulated information on employee behavior, contracts, facilities, and documents and facilitates management of compliance with security clearance standards.
This Raleigh-based company has developed the Sunscreenr device that allows consumers to see whether they have missed a spot when applying sunscreen. They have successfully completed crowdfunding campaigns on Kickstarter and Indiegogo, and plan to deliver their first products to consumers in Q2 2017.