When companies hear about the prospect of investment crowdfunding - raising equity or debt from many people typically in smaller amounts with the intent to receive a return on investment, they say "this is great, but what's the catch?"
My answer is: 1) you are going to have lots of investors in your company (which isn't necessarily a bad thing) and 2) it's going to cost money to raise money. This last part comes as a surprise to many who are familiar only with rewards-based crowdfunding like Kickstarter, which is traditionally less costly as it is smaller in size, scope, and most importantly not a regulated sale (though state attorneys general are beginning to crack down). Whereas, on the investment crowdfunding side we have legal fees, accounting fees, portal fees, marketing and PR fees, amongst other costs. This can quickly add up to $30,000 for a $300,000 offering. So, what's an issuer (the company raising the capital) to do?
Well, I like to advocate for a pre-crowdfunding private round of capital to raise the $30,000 or so in campaign costs via a convertible note offering. This financing round acts like a bridge and primes the pump, if you will, ideally allowing the company to breathe a bit easier and take the ultimate crowdfunding campaign at a normal pace, as opposed to rushed and frenzied.
So, here's how it works - the company offers "friends and family" an unsecured promissory note which is designed to convert into the equity sold in the pubic crowdfunding round, but – and here's the kicker - the investor is rewarded for backing the company at this early stage by receiving a conversion "discount" of somewhere between 10-25% to the equity sold. So, upon closing of the equity round, the convertible note investors are buying shares at say, $.75 on the dollar, for instance. It's a win-win, since the investors receive a great perk (cheaper shares) and the company has the capital to properly execute the larger capital raise.
This by no means is the only way to raise seed capital, but absent a rich uncle, credit card debt, a Kickstarter campaign, or money the founders happen to be sitting on, this path can prove to be quick, easy, and successful!
Zach Robins is a securities attorney in the Corporate & Transactions practice group at Winthrop & Weinstine, PA. He counsels clients in the areas of general corporate, M&A, private equity raises and debt financings. Zach co-drafted Minnesota’s intrastate investment crowdfunding law, MNvest, and counsels issuers, portal operators, investors, banks, and service providers on the nuances of state and federal crowdfunding laws, amongst other securities issues.