Raising capital is one of the most important, and intimidating, decisions in the life of a young company. Founders have long had to worry about questions around valuation, dilution, and the impact of potential investors. Now that the JOBS Act has been signed into law, a whole new set of opportunities has been opened through crowdfunding.
However, while there has been much written about the need to protect investors who crowdfund, there has been little talk of what companies need to look for in a crowdfunding portal. Below are four things companies should consider when selecting a crowdfunding source.
1. Find Out About the Site's Investors
Just as you care who your investors are, you should care who is investing in the crowdfunding sites you're considering. If a crowdfunding site is connected to great investors, its founders are likely also connected to great companies in an industry. Those connections help ensure deal flow, and great deal flow is what attracts the kinds of investors you want as part of your shareholder base. Additionally, crowdfunding sites with a strong reputation in an industry can form valuable partnerships with strategic investors, who can offer an eventual exit option for your company.
2. Beware of Adverse Selection
If a crowdfunding site is populated by adverse selection, meaning it's littered with tech companies who could not raise money from established channels like VC firms or angel groups, it probably means the quality of company on the site is relatively low. That, in turn, attracts less savvy investors. Look for sites that list high-quality companies as users. Those companies imply great deal flow, meaning the crowdfunding site can connect you with a good pipeline of value-add investors.
There are some industries, like business services or consumer products, that are an exception to this rule. In those sectors there are few institutional investors who will write checks for sub-$5 million businesses. In those cases, crowdfunding sites can attract top-tier small companies, and the top flight investors who want to be a part of these companies.
3. Check On Security
As part of the crowdfunding process, companies are sharing a lot of sensitive information with potential investors and the crowdfunding portal, so you need to be sure your information is safe. You should look for crowdfunding sites that are registered broker-dealers, as these are the only sites allowed to broker equity securities. You should also seek out sites that provide legal consultation, escrow services, and other technical security protections, all of which can protect your interests during the capital raise.
4. Know the Legal Documentation
When you raise equity capital, at the very least, you will need to sign a stock-purchase agreement, investor-rights agreement, and potentially amend your certificate of incorporation to create additional shareholder classes. Most crowdfunding portals will have a relatively standardized set of rights and covenants to offer you for these documents. While it is critical that your attorney review these, there are certain key provisions you should look out for and understand on your own.
For example, what are the information rights for investors' stipulated in the investor-rights agreement? A monthly reporting obligation will place a different demand on your time than a quarterly one. Another thing to look out for: Do you, your company, or a group of investors you know well have drag-along rights for a potential liquidity event? Your shareholder base will grow significantly as a result of crowdfunding, and a rogue shareholder or group of shareholders can derail a subsequent capital raise for you. Drag-along rights allow you to force minority shareholders to agree to a liquidity event if a specified group of your other shareholders agree to it. Other issues, like whether you will be selling preferred or common stock and provisions around valuation, are critical too. Make sure you understand how all these items affect your company and your wallet.
Image courtesy of iStockphoto, djgunner
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