One of the exciting developments in the world of startups recently has been the proliferation of new ways for companies to raise capital. There has been a push to open up the capital market to make funds more accessible to startups. In general, these new funding alternatives are separated into two categories: (1) non-equity crowdfunding, and (b) equity crowdfunding.
Non-equity crowdfunding provides the opportunity to raise capital without selling equity or borrowing money. The company (oftentimes through websites such as Kickstarter or Indiegogo) raises capital by tapping into the “crowd” for small contributions from a large number of funders to finance a particular project.
In essence, the company promises the funders some prize, gift or other token of their appreciation for the contribution (but not a return on capital). These rewards take many forms, including a pre-buy of the product that the startup is seeking to create, and range significantly based on the creativity of those behind the startup.
This funding source is an exciting alternative for companies that are looking to raise capital for a particular project or purpose, but this capital is typically not as well suited for a company looking to fund the growth of its business.
That said, with non-equity crowdfunding, the ownership of the company founders is not diluted when the capital is raised (because there is no sale of equity), and the company is not burdened with an obligation to repay the funds (because the contributions are not a loan) or pay any dividends on the contribution.
For other startups that are looking to fund growth of a business, raising capital by selling equity is more appropriate. While companies have been raising capital this way for many years, there are some exciting developments in the world of equity fundraising that may prove beneficial to startups.
First, under the Jumpstart Our Business Startups Act (the “JOBS Act”), passed in 2012, companies are permitted to raise capital in a “general solicitation” to “accredited investors” (i.e., investors that satisfy certain financial criteria) with limited filings with the Securities and Exchange Commission (the “SEC”).
While any company seeking to raise capital in the public markets should do so only with great care, access to a larger pool of investors could be an important funding alternative for the right startup.
(Note: The SEC has proposed amendments to its existing regulatory framework for public solicitations to accredited investors which have not been adopted and have been vigorously opposed by, among others, the securities regulatory committee of the American Bar Association. These amendments, if adopted, would be both burdensome and in all likelihood expensive to companies who elect to do the general solicitations to accredited investors under the JOBS Act.)
The JOBS Act also created a framework for startups and other companies to raise small amounts of capital from a large pool of investors, even investors that are not so-called accredited investors. In essence, under this framework, companies may access the “crowd” to raise small amounts from a large pool of people. The underlying theory is that the crowd will effectively be able to access the risk in these transactions, while providing startups with what is presumed to be a large pool of untapped capital.
However, while the regulations required to implement equity crowdfunding have been proposed, they have not been adopted. While the purpose of these proposed regulations is to provide investor protection, as drafted they will have the effect of stifling the kind of capital market creation and access that the JOBS Act was intended to create. What this means for startups, is that while equity crowdfunding sounds at first blush to be an exciting financing alternative, it has not (yet) proven to be an accessible source of capital, and in any event cannot be used until the implementing regulations have been adopted by the SEC.
Overall, startups that are looking to raise capital should be aware of the variety of different rules and regulations that apply, depending on the path that the company is considering. If the company is considering raising capital using non-equity crowdfunding, then while the federal and state securities laws generally will not apply, there are certainly other limitations that must be taken into account (including consumer protection laws and exposure to personal liability).
For companies that are looking to raise capital by selling equity, there are now opportunities to do so with accredited investors both in private placement (which has been a very popular tool for startups) or by making general solicitations. While there has been enacted a framework to also tap into non-accredited investors through equity crowdfunding, that alternative has not yet proven useful, and has a number of requirements that in all likelihood would prove to be costly to the company trying to raise capital.
I remain optimistic that as the capital markets progress and the need for startup capital continues, the usefulness of these various tools will become more apparent and the capital markets will be more accessible.
Please note that this article is intended for general information purposes only and is not legal advice.
Boot Camp for Startups: Please join me on Tuesday, June 17 (note the date change) from noon to 1 p.m. at Alpha Loft (formerly abiHUB) in Manchester, where I will be expanding on this and other topics in a seminar titled “Start-Up Capital: Traditional Sources and New Approaches.”
This will be the last of nine monthly seminars in Alpha Loft’s “Launch Series: A Boot Camp for Startups.” Email firstname.lastname@example.org for more information or to register.
If you’re unable to attend the June 17 presentation, I’m happy to answer your posted questions at http://unionleader.com/expert or http://abihub.org/our-residents/ask-the-expert/
Matthew H. Benson is an attorney at Cook Little Rosenblatt & Manson in Manchester, where his practice focuses on representing startup and other entrepreneurial companies with various business and commercial matters. He can be reached at email@example.com and followed on Twitter @matt_benson.