Can Entrepreneurs Raise Fast Funds from Friends and Followers?
Question: Can I sell shares of stock in my new company online? Non-profit organizations and politicians raise money through their web sites, so why can’t I. My plan is to raise $100,000 by asking people to donate just $50 through PayPal. What do you think?
Answer: Savvy entrepreneurs are always looking for faster, easier ways to build their companies,including how they raise equity capital from investors. It’s no wonder that entrepreneurs today want to leverage their online networks to solicit funds from their online “friends,“followers,” and “fans.”
Is this a good idea? While I give you a thumbs up for creativity; state and federal regulators would give your fundraising plan a big thumbs down on execution. Here’s why.
Unfortunately, there is a long history of shady opportunists selling worthless stock to the public. It’s not just billion dollar frauds like Bernie Madoff that concern regulators and duped investors, it’s all the well-disguised mini-Madoffs who have no intention of operating a legitimate business or repaying investors in an honest way.
To comply with regulations to minimize securities fraud, entrepreneurs have to register the securities they intend to sell to large numbers of individual investors with the U.S. Securities Exchange Commission. As part of this process, entrepreneurs must prepare an extensive description of their business and the securities offered for sale. This legal document, called an “offering memorandum” plus other requirements can easily cost $10,000 to $25,000 in legal fees.
Is this a good use of an entrepreneur’s precious capital? Not always. Unfortunately, not all corporate lawyers inform first-time entrepreneurs of the ways they can sidestep hefty legal bills and still comply with state and federal securities regulations.
In general terms, one of the most common work-arounds for entrepreneurs who want to raise less than $5 million and qualify for an exemption to registration requirements is to solicit “accredited investors.”
An accredited investor is a wealthy individual who can supposedly “afford” to lose part or all of their investment without causing serious family hardship. The SEC defines accredited investors as individuals who have a net worth of $1 million. The annual income requirement for accredited individuals is $200,000 or $300,000 for joint family income.
Recently Congress and the SEC tightened up the definition of an accredited investor. Now, individuals cannot include the value of their primary residence in the net worth calculation. The value of any first or second mortgages on a primary residence are also excluded from the net worth calculation provided that the value of the home is not less than any indebtedness that is secured by the individual’s primary residence.
There are other types of investors that qualify as “accredited investors.” Venture capital funds, banks, insurance companies, small business investment companies (SBIC), and certain charities, corporations, partnerships or trusts with assets greater than $5 million can qualify as accredited investors. A director or executive officer of the entrepreneurial company selling securities can qualify too.
I do appreciate that asking wealthy strangers to invest in your business can seem intimidating, but it can also be empowering. Raising money for a growing business is an important achievement that gives entrepreneurs extra confidence to tackle tough business challenges.
Check out the SEC Website for more rules associated with small business equity fundraising.
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