5 PROBLEMS WITH TITLE III EQUITY CROWDFUNDING
The Title III equity crowd funding ruleswent into effect recently, and many entrepreneurs, funders, and financial analysts are wondering if “retail investing” is all it’s cracked up to be.
While Title III theoretically opens the floodgates to literally billions of additional investments there’s a downside as well. If you’re completely green to Title III, here are some potential drawbacks to keep in mind:
Loss of Investor Partnership
Most investors are more than piggy banks. In many cases, investors act as both partners as well as navigators of local entrepreneurial ecosystems. The investors make connections, give advice, and, sometimes, help secure additional funding.
Often times, this type of support is necessary for healthy deals. But under the crowdfunding model, it’s uncertain if this type of support will be present, where it will come from, or how expensive it will be.
Investors are more than backers – they need to be managed. And the more investors, the messier the cap table and the more difficult management becomes.
This holds true for all parts of the process. In the pre-funding phase, these crowdsourced investors will want to know how the money is being spent. In the post-investment phase, buy-in will be required from the investors for decision making in many cases. And up until the investors exit, they will need to be communicated with on an ongoing basis about what is happening with your company.
The main costs associated with a Title III equity crowd funding campaign are accounting, legal, platform commissions, and marketing and communications expenses.
Accounting is one cost that entrepreneurs seeking crowdfunding will have to absorb, as follows:
For asks up to $100,000 – the business must provide financials for the past two years certified by CEO;
- For $100,000 to $500,000 – financials must be reviewed by an independent public accountant;
- For $500,000 to $1,000,000 – Financials must be reviewed by a CPA.
Since audits typically cost up to $20,000 it’s easy to see how quickly expenses can mount.
Legal fees can vary, and will protect entrepreneurs from accidentally misleading investors and from non-compliance with SEC guidelines. Marketing expenses will be required to actually win the crowdfunding and to maintain investor relations. Finally, most crowdfunding platforms charge a 5-7 percent commission on amount raised.
More Legal Risks
Non-accredited investors have certain legal protections that accredited investors don’t have. This shifts the burden of risk from the investor to the business.
These risks can be managed only with costly legal counsel. Until the market matures, it is likely that legal costs will be high
For example, crowdfunding platforms seem to be structured in such a way that is accommodating to class-action lawsuits. For instance, investors who have lost money may argue that they have been misled. These are the types of contingencies that lawyers will be considering – and billing for.
Low Cap on Asks
Currently, the most a company can raise under Title III is $1,000,000 per 12 months. However, the average ask for seed funding is twice that amount ($2,000,000).
As such, Title III funding could leave many businesses under capitalized. Those seeking more than a million could, in theory, go for Series A funding simultaneously, but in nearly all cases this won’t make financial sense. Title III is just too expensive.
In any case, it’s too early to know how Title III will change the fundraising world, or to prescribe any course of action for entrepreneurs. For example, it’s unclear whether the system is under-regulated in favor of early-to-market fundraisers, or over-regulated to their detriment.
Before beginning a Title III funding campaign, read up on the rules, and make sure you have sufficient capital; for an ask of more than $100k. If you can’t fund these accounting, legal, and marketing costs, then consider other sources of funding.
For more news on new and upcoming funding sources, sign up for our newsletter using the form on this page.