Crowdfunding is the new buzz in tech financing. Contrary to its publicity, though, it’s not for every business; in fact most businesses looking for financing either won’t qualify for, or won’t want to use crowdfunding to raise capital. Here’s a quick five for a business to consider on the “con” side of crowdfunding:
1. It’s going to be expensive to get your business ready for the crowd.
First, crowdfunding is technically an exemption to registering an offering with the NC Secretary of State’s office and federal securities requirements. One must determine whether the offering qualifies for the exemption, and in order to qualify one must comply with the PACES rules. Use of the PACES exemption has *multiple* requirements (e.g., obtaining and providing proof that all investors are North Carolina citizens) that can get expensive, beyond just legal fees (audited financial statements in some circumstances, for example).
In addition the SOS hasn’t yet issued regulations governing PACES fund raises; there will likely be more disclosures required. It’s been my experience that many small businesses don’t have the proper foundational and operational documents in place (Bylaws, shareholder agreements, loan documents, to name a few). These will all have to be created and put in place. Good for me, because I enjoy doing that. Bad for the fundraiser because it means delay and expense.
2. Your business may not be “crowd” ready.
Crowdfunding is truly that – raising money from a crowd of strangers. If you own an ice-cream shop and raise, say, $10,000 from 100 investors, do you really want them showing up at all hours to “keep an eye” on their investment? Additionally, the PACES Act requires *quarterly* reports be provided to all investors (which can be posted online) while those shares are outstanding. As an ice-cream shop (insert your small business here) owner, do you want to be selling ice cream, or filling out quarterly reports?
Investors are owners; they traditionally get a say in how your business operates. Do you want to give voting power over your business to strangers on the internet? Sure, traditional private equity investors will own your business too – but if you go that route you meet with, interview with, consult with these investors; often private equity is sought because of their expertise or connections. This process assures an owner that he’s giving up ownership to someone s/he can work with. Not so with the crowd. Total strangers, which can include trouble makers, weirdos, retired little old ladies (seriously, if your business goes under do you want to be associated with taking a little old lady’s retirement money?). To keep control of this, don’t crowdfund.
3. Your raise may not be appropriate for investors.
Sometimes a business needs money. But that money is not always best found from new shareholders. In fact, savvy investors will *not* invest in a business if you’re raising capital for certain things (unless they’re trying a takeover or getting majority control). For example, if you’re having trouble making payroll, or paying bills, an investor will likely not give you money for that. If you want to give your owners/officers a raise or start buying health insurance or pay down debt, that’s another non-investor raise. There are other, more traditional sources of capital for certain items like these, for example, a bank line of credit, or factoring outstanding invoices (don’t do this, by the way).
4. You don’t want to disclose who really owns your business.
North Carolina’s PACES Act requires disclosure of anyone who owns more than 10% of a business. Not everyone wants their name associated with certain business investments, let alone on the internet. That could be a disqualifier right there.
5. You want to control who really owns your business.
Certain businesses can only be owned by qualified persons, such as law firms being owned by lawyers. Similarly, businesses like liquor, security, or gun sales may have background check requirements for owners. You can’t disperse your qualified business ownership to non-qualified persons through crowdfunding.
I’m sure there’s plenty more reasons not to crowdfund; these are just a few I came up with talking with someone this morning about it. For this and all your businesses legal needs, call me in Asheville, Hendersonville, Fletcher, Waynesville, and all of Western North Carolina at (312) 671-6453, email at palermo@palermolaw.com, or for more information palermolaw.com.