A mentor of mine used to refer to the process of preparing a securities offering for public investors as a “craft”. He would explain to me:“Before you can sit down and write the offering based on your clients’ specifications, you need to be able to see the offering through the eyes of the prospective investors.”
Crowdfunding is creative finance. Crowdfunding comes with endless possibilities for creating a variety of unique financing transactions. Each company sets the terms that they will offer to investors. Investors get to say “no thank you” to those terms if other investments are more appealing.
Many people who work in crowdfunding don’t know the first thing about finance. This limits their creativity and often dooms a crowdfunding campaign that should have been successful.
When speaking with a company seeking an infusion of capital, many crowdfunding “experts” give cookie-cutter advice. Some companies use templates to create their offering instead of lawyers. Those companies will never know that there is usually a better way to approach their financing that will be more attractive to investors and at the same time save them a lot of money.
Creating an attractive investment for an audience of targeted investors on a crowdfunding platform involves a series of tasks. Much of it involves a lot of time looking at spreadsheets. If you don’t, at the very least, do the following while preparing your crowdfunding campaign, you are likely wasting your time and money.
Before I structure an offering I expect to review the company’s current financial position. Only then can we decide whether the financing should be debt or equity, whether it should be on or off balance sheet and whether the offering should be for more or less.
You need to be able to demonstrate how you will use the investors’ money and how that money will generate revenues. Your revenue projections need to be supported by real world data and real world assumptions. “We’re going to capture 50% of a billion dollar market in 2 years” is fantasy, not finance.
Every financing transaction has a risk of default or sub-standard performance. You need to understand the specific risks of your business and how to mitigate those risks. You will need to estimate how much of a reward it will take to compensate your target investors so that they will accept those risks.
Crowdfunding overwhelmingly operates in the Regulation D market selling private placements to accredited investors. A great many of the accredited investors who you are likely to pitch for your offering have more likely than not, already been pitched to purchase a private placement
Since the 1980’s the mainstream stock brokerage industry has sold private placements to millions of individual accredited investors. Various types of real estate offerings are the most popular, followed by energy (oil, gas, and solar), films, entertainment and events and equipment financing.
For over 40 years the mainstream brokers have been selling investors on the idea that private placements provide passive income. Accredited investors are also used to being pitched that private placements come with higher returns. Most crowdfunding is directed at these same accredited investors. You need to give them the information and the pitch they expect to hear.
The vast majority of accredited investors are baby boomers. They still control the bulk of the money in the Reg. D market. They have grown up with new tech and new companies and they are not afraid to invest in either. But new tech is always risky. You have to offer a return commensurate with the risk.
Crowdfunding as we know it today began with a rewards based model. A company would sell its product on a platform like Kickstarter and use the proceeds from the sales to manufacture the product. Much of the time, the product never got delivered.
During 2016-2017 there was a lot of discussion among Crowdfunders about a financing model called “revenue sharing”. In its basic form, a company would raise money from a pool of investors, manufacture the product and then share the revenue with the investors.
Revenue sharing is actually a mainstream tool of modern finance. Many oil drilling programs pool investors’ money to cover drilling costs with the investors and land owners, sharing in the revenue if and when it strikes oil.
Many franchisers use a revenue sharing model with their franchisees. The parent gets a percentage of the franchisee’s gross revenue structured as a franchise fee, rent, or a royalty on intellectual property. The parent often provides advertising support or promotions to help build sales.
Accredited investors that have purchased Reg. D offerings are familiar with this “slice of the revenue pie” structure. They understand that they will earn less if their oil well pumps 10 barrels a day than they will if it yields 100 barrels a day.
As I have already mentioned, there was for a while a lot of discussion about revenue sharing. Several platforms were going to come on line to specifically offer revenue sharing programs. Revenue sharing is a natural for a crowdfunding audience. Unfortunately it never really took off in the way that I would have expected.
The crowdfunding industry is still focused on the “buy equity in the business” model, It has gone out of its way to create derivatives like SAFEs to complicate what should be simple capital raising projects.
The crowdfunding industry needs to accept the fact that businesses with no sales or assets are not “valued” at hundreds of millions of dollars in the real world. Insane valuations actually hurt the crowdfunding industry because they drive away serious investors. Many of those same companies could use creative revenue sharing models instead of trying to sell equity.
I recently spoke with a business owner willing to sell 10% of his business for $2 million. He wanted to syndicate a Reg. D offering and raise the money on a crowdfunding platform. He was having a good year and wanted to expand.
The company sells an automated HR suite to businesses with at least 100 employees. Its customers pay monthly, per employee. The company wants to use the $2 million to open
The company knows the cost of account acquisition and expects at least $10 million in additional revenue in the first year from its $2 million expenditure. Those new accounts are likely to stay customers for many years.
Instead of selling 10% of the company, I suggested that he share the income stream with investors, pay them back quickly with a generous return and move on. It makes perfect sense.
The company might give the investors 60% of the revenue from these new accounts until the investors get distributions equal to $3 million and then cut them off. They can pay the investors more or less and carry the payments into the future, if they prefer. The company should easily be able to attract $2 million with the promise of paying back $3 million in only a few months.
In this case I would advise the company to take the investors into a separate limited partnership or LLC. Investors like this structure for a number of reasons, not the least of which is that can get paid on the gross sales. They are not concerned about executive pay or management issues. How the company spends its 40% the first year is not the investors’ concern.
The company does not have to deal with investors on its books and all that entails. This relationship operates and terminates by contract. If the company wants to sell 10% of its stock later, it will get more if the sales have been increased by $10 million per year.
I have seen many advertising campaigns funded this way. I have seen companies with multiple products fund one product or even one cargo of its product this way. Most of the crowdfunding “experts” have never recommended this type of revenue sharing arrangement because this type of offering rarely shows up on crowdfunding platforms.
This $2 million gets you $3 million model does not work for every company, but there are other “fund the transactions, not the company” models that may. These are only one alternative to the traditional equity method. There are others.
As I said, crowdfunding offers opportunities for creative finance but you need to understand finance
, in all its forms , before you can really get creative.
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