Too many people in the crowdfunding community seem to think that the crowdfunding industry exists solely to provide access to capital to small entrepreneurs who have previously been denied access by the evil banks and brokers on Wall Street. 

I think that the crowdfunding industry will eventually grow and compete with the mainstream banks to fund the same credit worthy companies. The industry just needs to point itself in that direction, something it has been reluctant to do.

Fundraising for start-ups has become remarkably easy with the JOBS Act and equity crowdfunding.  A good, well-funded and professional crowdfunding campaign should receive the funds it seeks every time.

Still many small companies struggle to raise even $50,000 on a Reg. CF funding portal.  Too many of these small Reg. CF offerings fail to raise all of the funds they seek. Part of the reason is that, statistically, 90% of start-ups will fail.

The total universe of investors who might invest in these start-ups is a very small segment of the total number of investors and represents a limited pool of capital. The challenge for any issuer that is crowdfunding for capital is to reach out to enough of the right investors and deliver the right message about your company to them.

Many of the crowdfunding “experts” seem to view investing in start-ups and small businesses as gambling, not finance. That is because many of the funding portals and “experts” know very little about finance.  Some of the portals seem to list any company that can pay the upfront fees.

A great many of the start-ups that seek funding on the Reg. CF funding portals do not deserve to get funded. The offerings are, for want of a better word, crap. The business model they present is unlikely to succeed. Investors are likely to experience a total loss. These companies need to either get their act together or just give up on the idea of getting strangers to fund their business. 

When I read a business plan, I can usually tell if the company has at least a good chance of success or not. It is more than me making an educated guess because there are usually clear signs. Operators of Reg. CF funding portals are supposed to make the same judgment and refuse to host an offering that presents an “impractical” business plan.

Unfortunately, some of the portals do not seem to understand their responsibilities as FINRA members.  Several of the funding portals have no personnel on staff with any experience in any aspect of selling securities, let alone compliance with the regulations. 

I recently joked that what the crowdfunding industry needed most was an introduction to Benjamin Graham because most people operating funding portals think Ben Graham invented a cracker. It is only funny because it is true. 

Several years ago, FINRA expelled crowdfunding portal UFP (uFundingPortal), in part for listing companies with “impractical” business plans. Despite FINRA’s clear warning to the funding portals not to host these types of offerings, many of the funding portals continue to ignore FINRA. 

So what, exactly, does FINRA mean when it is telling funding portals not to list a company that has an “impractical” business plan? It starts with what the company that is raising money is trying to accomplish and whether or not, following its business plan, management has a reasonable chance of making it happen.   

The presentation of an offering on a funding portal should eliminate much of the hype and exaggeration. Notwithstanding, many entrepreneurs are clearly being encouraged to “dream big and promise big” by funding portal operators. If a company is raising capital from investors by making promises it is unlikely to keep, then its business plan is “impractical”.

I think that everyone would agree that a company that is raising $100,000 and promising that it will be enough money to build a skyscraper in Manhattan or to develop a drug that will cure all cancers has an impractical business plan. The same would be true if the skyscraper was not designed by an architect or the drug was intended to be sold without FDA approval. 

A business plan that suggests that the company will sell one million units of its product using social media would be impractical if the company did not have some way of backing-up that assertion.  FINRA has a consistent policy that requires that there be a reasonable basis for all sales and revenue projections. 

As the regulators move forward I think that they will find that a company that intends to market a product that infringes on another company’s patent has an impractical business plan. But not every case will be as clear cut.

Can the Management Deliver?

Investors know that 4 software developers writing code and a CFO do not equal an operating company. It helps if the company has people with experience in the industry in which the company will be operating. At a bare minimum, every company seeking investors should have managers that have experience in managing people. 

With start-ups, it is a red flag if the CEO does not have experience managing a lot of people. It is one thing to get people to work well together and produce the work that needs to be done. It is another in this day and age to comply with often complex workplace rules.

Investors like to see that a company has a marketing director with real experience selling similar products. If the company is not yet ready for a full-time marketing director then the company should at least have someone with marketing experience as an advisor or on the board of directors. For many companies the cost of new customer acquisition is a key metric and may be a foundation for all financial projections.   

I listen when a company tells me that its product will sell millions of units or become a ubiquitous part of everyday life. A company should be able to demonstrate not only that people will want to buy its product but that it can produce it profitably, deliver it efficiently and sustain both.

I always ask about a company’s supply chain.  It is fine if all the company has is a prototype at this point, but if it expects to sell 100,000 units in the first year, it should be ready to explain where the company will get those units, what they will cost and how those units will be distributed.

For a pre-revenue or unprofitable start-up, I always ask the company when, in terms of revenue, will the company breakeven. A company that claims it will see double or triple-digit growth needs to be able to support those claims and demonstrate how and why they will come true.

“If we build it, they will come” is not the best approach for realistic sales and sales growth. Even a start-up should be able to make realistic assumptions based upon proposals give by outside marketing firms.

All of the above is encompassed by FINRA’s rules governing how a Reg. CF funding portal is supposed to operate. The regulations include provisions that are firmly rooted in the idea of investor protection and textbook finance.

New rules allow the funding portals to raise up to $5 million for every company. There has been a significant uptick in funding portal applications.

Small investors are being hyped with the idea that crowdfunding portals are offering opportunities for them to invest in the next Facebook or Amazon that will turn their modest investments into huge profits. The last thing the industry needs is more small companies with dubious products and inexperienced managers competing for investors’ dollars.    

The regulators will never accept the idea that investors in the crowd can be left to fend for themselves or that proper disclosures do not need to be made. Equity crowdfunding is not a caveat emptor marketplace. 

A funding portal is a regulated financial intermediary. It is a very small industry with a single regulator, FINRA. Widespread disregard of those regulations is not good for the industry’s long term health.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE