New equity crowdfunding regulations that began taking effect last year have transformed the landscape for both entrepreneurs and investors in America. By enabling non-accredited individuals (the vast majority of the population) to invest in early stage startups for the first time, these new regulations have not only leveled the playing field of investing, but also uncapped a completely new source of funding for new growing companies. The new rules were a long time coming, as they were first passed by congress and signed into law in 2012. Only last year, after years of debate and discussion, did the Securities and Exchange Commission (SEC) actually begin to implement the first of these rules. So needles to say, it’s a very exciting time to be in the crowdfunding industry.
Entrepreneurs can see the possibilities.
To understand what makes an equity crowdfunding campaign successful, we recently completed an analysis of the first year of so-called Regulation A+ equity crowdfunding campaigns (Reg A+ is one of the popular forms of equity crowdfunding that took effect in June 2015).
We chose to analyze these Reg A+ crowdfunding campaigns because those rules have been in effect for a longer period than the so-called “Title III Regulation Crowdfunding” rules. And, more importantly, Reg A+ will likely have the largest impact on the securities market of any form of crowdfunding. The potential to re-energize the early stage capital markets has led hundreds of firms to explore how to raise up to $50 million per year using these regulations.
But in order to understand where the hype ends and reality begins, entrepreneurs who are considering using any of the new equity crowdfunding regulations should understand three important tips that often mean the difference between success and failure in an equity crowdfunding campaign. After all, this isn’t Indiegogo or Kickstarter where you offer rewards — t-shirts, posters, books or gadgets — in exchange for financial backing. Offering equity shares in exchange for crowdfunding investments is entirely different.
Lesson 1: Marketing is key.
The dramatic changes in securities laws that allow entrepreneurs to solicit investors regardless of their income level has upended 80 years of securities law. Under Regulation A+, entrepreneurs can legally reach out to retail investors in additional to accredited, qualified or institutional investors.
Successful Reg A+ raises rely on superbly executed multi-channel marketing campaigns. From interviews with successful firms, it is clear that the first place to start is targeted advertising through social media (primarily Facebook). Remember, you are moving beyond “the 5Fs” — founders, family, friends, fans and fools.
It takes money to be successful — typically at least $100,000 in legal, accounting and other compliance costs, and another $50,0000 – $250,000 in advertising. With budgets like these, you must first do a test to determine ad response rates and the acquisition cost of each investor. Our analysis found that the average investment is around $2,000. However, it is best to be conservative when estimating your needed social media budget. In calculating your cost per investor acquisition (CPA), a safe estimate is to assume that each investor puts in only $1,000. Firms like Serenity Ventures are starting to offer a Crowdfunding Scorecard that estimate your CPA and funding likelihood, to allow better planning before committing to the legal and accounting bills.
Lesson 2: Bring your community.
As an active investor, I receive dozens of solicitations a week through social media channels. I have never made an investment outside of my areas of expertise (that’s not to say others won’t). Firms that are very successful in equity crowdfunding bring substantial online and offline communities to the raise. By substantial I mean tens of thousands of online followers and at least several thousand opted-in names to your active mailing list or newsletter. Most firms who have success in using Reg A+ are also in a sector with a passionate and engaged community — think of local food/distilleries, gaming or VR, or of experimental aircraft associations or communities organized around specific health challenges (diabetes, breast cancer, etc).
If you can’t engage the passion and emotion of a pre-existing consumer industry, it will be hard to mobilize retail investors. Banks and real estate investment funds are using Reg A+ as an alternative way to raise investment capital — but startups and emerging companies must have connection to an existing community and the ability to activate it. The crowdfunding platforms aren’t going to create your community for you or drive large numbers of investors to you without it.
Lesson 3: Timing is everything.
“Testing the Waters” (TTW) allows firms to communicate with potential investors and receive “expressions of interest” from potential investors before the firm officially files their investment offering with the SEC.
While the SEC deserves a substantial amount of praise for honoring its commitment to provide a streamlined and rapid review of the required form filings, it can still be two to four months between filing and having your offering approved by the SEC. This requires delicate timing. If you start your TTW stage early and leave it open for four to six months, it appears that you are likely to lose a substantial number of investors — too much time passes and they lose interest.
If an entrepreneur is using TTW as a way to mobilize investor interest for a campaign they are committed to launching, then they may wish to delay the TTW for a month or two after filing with the SEC.
Reg A+ is an exciting, relatively low-cost and streamlined way to raise tens of millions of investment dollars, but it requires expert guidance and a product or service that engages your core community (which can be your base of existing customers).