Crowdfunding a startup: rags or riches?

by Rick Colosimo on May 20, 2010

Crowd-everything is super hot, and super cool. The vastness of Wikipedia alone is sufficient to teach every one of us that when “crowd” is applied to your field, really neat and seemingly impossible things can happen.

To me, “crowd” is just the plural of “open,” as in open data.

But crowd doesn’t always work, and crowd doesn’t always scale (or, as I’ll discuss here, not in the right way).

Since Kickstarter got a lot of press as a way to make “projects” start moving with seemingly free or no-strings or on-my-own-terms money, people have been asking me about extending this to startups as a [pre-]replacement for venture capital and angel investment, both of which are seemingly harder to come by and once again slower in the bust than in the boom.

First off, we need to get a quick leader’s reconnaissance in, a lay of the land so that we’re all talking about the same thing. This is particularly important when it comes to “raising money,” which in startup-land usually means one very particularized thing, namely the sale of securities by an issuer to investors in an unregistered offering. Yes, I know I should have turned on the “legalese” tag for that sentence, but this is one area where you can’t fool around and paraphrase, or worse yet, euphemize.

Selling stock, warrants, options, and convertible notes to investors is generally always the sale of securities. Borrowing money through traditional promissory notes can be the sale of securities. The sale of securities is regulated up, down, and sideways by the federal government in the form of the SEC (and its regular partner, the DOJ) and by the states through the state attorneys general.

Take this lesson to heart:

1. Sale of securities  = highly regulated

2. Highly regulated => do yourself and your lawyer a favor and call before agreeing to do anything.

Securities law is one area of the law where even lawyers get lawyers. This is not DIY.

Your working model for securities should go like this: sales of securities require lots of expensive formal paperwork unless my lawyer tells me we have an exemption. Exemptions are available for most traditional venture investments (VCs are accredited investors and so are most real angel investors). Getting $1000 each from your cousins is generally not okay. Asking everyone you know or putting “raising series A” in your email sig are outright bad. These last two are examples of what the SEC may readily describe as a “public offering.” Public Offering, when it’s part of IPO, has a nice ring to it. When it’s part of your seed or series A round, it’s definitely flat.

Public offerings always require lots of expensive paperwork because that’s how you get to sell shares to everyone who wants them: the disclosure in the prospectus, written in “plain English” to comply with voluminous SEC regulations, is considered enough to allow a reasonable investor to evaluate the wisdom of buying stock from the company.

Crowdfunding, IF YOU MEAN selling securities to people through a nice public website with lots of visitors, is a problem. It’s almost certainly a public offering and will create big problems for you, the kind of problems that can easily kill a real venture financing.

Actually, Kickstarter itself doesn’t allow “investment and loan solicitations.” IndieGoGo, another site, is “not offering equity investments.” (I think it’s good that these sites are keeping people out of trouble.)

Advanced Masterclass Tip: you could conceivably use this method to sell securities only to foreign investors, but it’s probably not worth the trouble of trying to make the required restrictions fit into a site that’s designed to show everything to everyone. You’d be better off looking for some sort of angel investment opportunity site — which would at least be more likely to keep you out of inadvertent trouble.

NEXT: Crowdfunding a startup: what does work?

Post or email your questions on crowdfunding, and if they’re not already planned in the next post, I’ll work them in.

Are any of your intrigued by soliciting an investment in yourself, paying back with a portion of your earnings? The FAQ page is, sadly, empty; questions abound that the “template” contract doesn’t answer.

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Getting crowdfunding wrong
May 28, 2010 at 3:09 pm
Innovative selling models are constrained by the law
May 13, 2011 at 2:03 pm

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