Most people who consider crowdfunding to raise capital for their business are first-timers. A great many have never even been investors themselves nor considered investing in any of the companies whose offerings are currently on any of the crowdfunding platforms.
Economic downturns always present opportunities for people with the capital to exploit them. I get more calls from CEOs and CFOs interested in crowd finance every week. Many have become interested because the banks they would normally turn to are not lending.
A crowdfunding campaign, if executed correctly can be an excellent source of capital for most businesses. Like any other corporate task, it requires preparation, an adequate budget, and professional execution. Not surprisingly, everyone wants to know what a successful campaign to raise capital from investors will cost.
The “Real Cost”
Most companies will rely heavily on their CFO or outside financial advisor to execute this financing. The CFO needs to consider how the financing will affect the company’s balance sheet, cash flow, and capital structure. The company will need to decide if it should offer investors debt, equity, or another form of financing instrument.
The question of “what do we offer the investors” necessarily comes up early in the planning stages of every offering. The right terms can save a company a lot of money and make subsequent financing easier. The wrong terms can result in an expensive or failed campaign now or may erupt into a costly mess, years later.
For many CFOs the desire to offer investors as little as possible is at odds with the reality that if you do not offer investors enough, they will put their money elsewhere. This is where the “real cost” of any financing is determined.
Investors in every Regulation D offering are always advised that the securities they are purchasing are “very high risk” or “speculative” to the point that investors should be prepared, both mentally and financially, to lose their entire investment. When the risk is high, investors expect to receive a high return as well. Some risks can be mitigated and should be.
The process of deciding the terms investors will be offered usually starts with a series of spreadsheets. How much the company can afford to pay is in the revenue projections. How much the company may need to pay to attract investors requires a good idea of the cost of capital from other sources and a good idea of what other companies are offering in the crowdfunding universe.
I frequently participate in this process. This is because most of the platforms fail to offer this type of advice which most companies sorely need.
I like to ask the questions that investors are likely to ask. I try to help each company see the investment from the investors’ point of view. Wall Street firms sell billions of dollars worth of these private placements every year. They know what needs to be said to get investors to invest.
Regulation D securities will only be sold to US “accredited” investors, mostly those who have a net worth above $1 million (excluding their primary residence). For years the mainstream stock brokerage industry has conditioned these same investors to look at the return that is being promised to them first, and most do.
Investors want to know how you will use their money to make the returns you are promising come true. How you price and present your offering tells serious investors a lot about how serious and professional you are.
What to look for in a lawyer (if you don’t hire me).
Once you have decided on the terms you will offer to investors you will have 3 major out-of-pocket expenditures. The first is a securities lawyer to draft the offering documents. What you say to potential investors in the offering and marketing materials is regulated. A good lawyer will keep you within the regulators’ white lines.
The standard disclosure document for a Regulation D offering is called a private placement memorandum (PPM). The overriding requirement is for full, fair, and accurate disclosure of the information that an investor would need to make an informed decision of whether or not to invest.
PPMs have been presented as a bound booklet for decades. The bound booklet PPM is the normal format for disclosure that most practitioners still use. In booklet form, the cost for a PPM is typically $50,000 and upwards.
Crowdfunding websites have begun to change the format and have started to use landing pages to spread out the information about offerings rather than present it as a standard booklet. This format makes the offerings more readable and investor-friendly while still making all of the necessary disclosures.
The landing page will provide investors with the terms of the offering, a description of the business and its principals, and a table showing how the company will use the money it is seeking. Most include links to current financial statements and revenue projections. The same information about the business, its competitors, and the particular risks of the investment that would appear in a bound booklet is all laid out. Key documents can be viewed with a “click”.
It usually takes less drafting and less time for a lawyer to use the landing page to “lay it all out” which is one of the benefits of crowdfunding. I usually bill in the neighborhood of $20,000-$25,000 for a Regulation D offering done in this manner rather than the traditional booklet form.
Paying for the Platform
Many crowdfunding platforms advertise that tens of thousands of investors have invested in at least one offering that they had hosted. Unless the platform can deliver those investors to you, such claims are irrelevant. You are going to need to execute a marketing campaign sufficient to bring in the capital you seek.
Platforms usually charge a “hosting fee” that covers two or three months for you to use their platform to attract investors to your offering and process them. The processing will include a vendor to verify that your investors are actually “accredited” and an escrow agent to hold the investors’ funds until closing.
Key individuals at each company are required to get a background check to verify that they are not “bad actors” who cannot use the JOBS Act to raise money. Platforms charge for this and the better platforms charge to conduct due diligence on the company as well.
Most platforms charge more the longer your offering is live. A well planned and executed marketing campaign should get you the funding you want faster. Expect to spend $10,000 more or less for the platform hosting and the background checks.
Never Take Marketing Advice from Your Lawyer
Working in financial services where so much of what you must say and cannot say is regulated; I came in contact with a lot of advertising and marketing professionals over the years. In the 1980’s, when stockbrokers went searching for accredited investors they would buy subscription lists from “Yachting” magazines.
A modern-day marketing campaign is skillfully targeted at a pre-selected group of prospective investors. Content is pre-tested and the campaign will target more potential investors than you should need.
The costs of setting up the landing page for an offering can vary greatly. I think that $10,000 is reasonable for setting up the website and preparing the marketing campaign.
Many Regulation D offerings have a minimum investment of $25,000. This equates to a maximum of 40 investors for every $1 million raised. A rule of thumb suggests that for Regulation D offerings, an expenditure of $10,000 on the marketing campaign for every $1 million raised seems reasonable.
So for a crowdfunding raise of $3 million, you might spend $20,000 for a lawyer, $10,000 for the platform and related fees, and $40,000 for the marketing campaign for a total of $70,000 more or less. I always tell clients to keep a little in reserve as well, just in case the marketing campaign needs to be extended.
If you borrow $3 million from a bank, the bank will charge 2 or 2.5 points (percent of the loan) as well which is roughly the same. And in truth many of the companies that chose crowdfunding did so because bank financing is not an option for them.
The crowdfunding world has evolved from “put the offering on the platform and see who invests” to a world populated by legal and marketing professionals who get the job done and the money raised. If you want your crowdfunding to be successful, be prepared to pay for them.
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