The True Cost of Equity Crowdfunding
I’m not an equity crowdfunding naysayer, but that doesn’t mean I see only silver linings on the horizon for the eventual implementation of Title III. Raising money is expensive. It is never free. Sometimes the cost is more expensive than just money. In fact, sometimes the most pervasive and costly aspect of money raising is the loss of time, which is our most limited commodity. If one considers the cost from a financial perspective, the costliest component in the capital-raising process is the sacrifice of equity in a growing business that could be ten thousand times more as its value accrues over time. Ignoring the ancillary and potential long term costs of equity crowdfunding, even if we focus on just the here and now, the cost of crowdfunding may be deleterious, especially for some of the smallest companies looking to raise money through this “sexy” new medium. Here are just a few.
Legal Fees
For the woefully ignorant entrepreneur looking to raise equity backing via a traditional PPM or equity crowdfunding campaign, the potential to rack up massive amounts in legal fees is staggering. Even if you’re attempting to do things on the cheap, the potential for racking up thousands of dollars in legal fees in preparation for your Private Placement Memorandum and the legal compliance forms required by the SEC makes raising $60K or less a complete waste of time.
There are some PPM preparation specialists out there that offer their services for less than $10K, but other compliance and regulatory pieces can help to pile-on added costs to your offering. To make up for the necessary cash outlay on the firm, some attorneys will also allow stock as payment. While rare, many would-be entrepreneurs would be well-advised against such a costly strategy. But cash is king and if the attorney is willing to get paid in private, illiquid stock for his/her services, it may be worth it to get things done.
Accounting Costs
Most private offerings may not require the stringency heaped on public offerings, like PCAOB and Sarbanes-Oxley compliance, but they still require the hard-look of a third-party CPA. Before savvy investors want to open their wallets for any particular deal, they’ll often require audited financials of the company in question, especially if the amount being raised is at all substantial.
If, on the other hand, your firm is in complete startup phase without any current funding and only a pie-in-the sky pro-forma, you’re not likely to need the accounting assistance, but it also means you’re likely to receive less money for more equity. Anything sold as an idea rather than a business with existing revenues and substance may save money on the accounting side, but is likely to lose out on both the equity given and the cash supplied. It’s advisable that most companies build something first and pay for some accounting help to paint a good picture, rather than drafting some rather assumptive pro-formas. Either way, accounting costs can mount quickly, especially the more legitimate the deal you’re presenting to would-be investors.
Banker Engagement & Success Fees
Self-issuers can do equity crowdfunding less expensively, but if you have engaged a banker, the fees change. If you’re chosen crowdfunding portal is simply a pay-for-post service and doesn’t hold an actual broker-dealer designation, you’re likely to save some coin on the posting of your deal for a face toward the public. Some FINRA registered platforms simply charge a success fee, which is likely one of the better fits for most cash-strapped startups. However, that doesn’t mean an attorney shouldn’t look at your PPM and offering docs before you go live—which is never free.
Unfortunately raising money for your business will always prove a necessary evil. Sourcing the capital isn’t always easy, but if it means building and growing a sustainable business going forward, then the costs may ultimately be worth it. In the case of equity crowdfunding, you may need to budget as much as $40K or more to ensure your crowdfund campaign meets all the legal requirements to do any type of general solicitation, even if it is just to accredited investors. Such costs, while somewhat prohibited for some business owners looking to raise small amounts of cash, can be simply a cost of doing business for others who have a much larger vision of growth for their companies long term. Assessing the various options and determining their relative costs will be important for any company looking to raise money. What you decide is likely to depend on your budget, the amount you wish to raise, your business and those that manage it.
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