In mid-2016, the Securities and Exchange Commission (SEC) adopted a new section of rules created under the 2012 JOBS Act that allows companies to offer and sell securities to the general public through crowdfunding. With the adoption of the new crowdfunding rules, business have a way to raise capital through the Internet for the first time – and also new lessons to learn about how to find the right kinds of investors.
We talked with attorney Nathan Roach, CEO and co-founder of MassVenture, Texas’ first state-approved equity crowdfunding portal. Roach was one of the first Rackspace employees, and has a background representing and connecting innovators, startups, and high-growth companies.
What Does it Mean to Find the Right Investor?
Until recently, the SEC said that companies could not raise capital through the Internet, and that only accredited investors could invest in private securities. The SEC defines an accredited investor as someone who has a net worth of greater than $1 million – excluding a primary residence – or someone whose household income is greater than $300,000 for those filing jointly or $200,000 for someone filing solo.
Those initial rules meant that only a small percentage of the population could get involved in funding businesses. But with the new SEC rules in place, the increasing number of small businesses and startups in the U.S. has a new option for finding capital.
Having access to investors is important – but just as important is finding investors that are the right fit for your business, says Roach.
“A business owner may be looking at their need for capital, saying ‘I need money to accomplish any one of my business goals.’,” Roach says. “A lot of the time the question of ‘what can the investor do for me and how can that relationship work’ gets subjugated to the need for money…if you’re successful and getting investment interest, the selection criteria seems to be ‘who is going to give me the most money,’ and not ‘who is the best fit.’”
But working with investors is about more than just gaining capital, Roach says. “You can find investors out there that align with your business – and you want to make sure investors are signing up for the same ride you’re going to be taking. You want to be sure they’re buying into this business for same reasons you’re trying to accomplish.”
What Needs to be Communicated to Potential Investors?
Why is that important? For one thing, the type of returns that investors can and should expect is different from industry to industry. Tech and startup funding, for instance, comes in multiple rounds. Entrepreneurs talking to investors in the seed round expect to go on to raise money in more series – and will need investors with contacts to bridge them through the next round, Roach says.
“When it’s time to do a Series A, you want someone who can make intros to bigger players down the road,” Roach says. “Or maybe you have a market specialty, and you want an investor who knows your market specifically.”
Real estate entrepreneurs on the other hand might want to connect with investors that know about the regulatory and business challenges a project might face. If someone raising funding for a real estate project gets a few hundred investors through crowdfunding from the city or neighborhood in which a project is planned, they now have a network with local knowledge.
Roach says zoning boards can often throw up roadblocks for real estate projects, for example. But zoning boards are accountable to the community, and they want usage in an area to align with what the community wants – so if 200 investors show up at a zoning meeting, that can be powerful.
“That doesn’t show up on balance sheets,” he says.
How Do you Find a Good Fit?
Searching for investors is an exercise in sales, Roach emphasizes. You’re selling your vision of the company, and where you see it going. And just like in sales, it takes a lot of conversations and contacts to generate an investment.
But the probably per investor that you’ll get a “yes” is higher if you go through organizations or industry groups. That’s not to say entrepreneurs should join groups like chambers of commerce or professional organizations just ask for money; those kinds of relationships take years to cultivate. Looking for networking groups where people you meet might become resources who can introduce you to investors is always a good idea though, Roach advises.
“I spoke with someone recently who is a member of a group that’s a professional organization of owners of ice skating rinks,” Roach says. “That just goes to show – whatever business you’re getting into, these are places where you can find contacts, and people who are aligned with your industry.”
Crowdfunding platforms are another way to connect with the right investors, because they provide a structured way to handle investments.
Depending on the size of investment you need, if you’re seeking an investment you may have thousands of conversations, and entrepreneurs need to be prepared to answer questions like “what are the terms of the investment?” and “where can I see the financials?” Crowdfunding platforms give entrepreneurs a way to have that conversation with a pool of investors who are already there.
Angel networks provide similar structure and opportunities, Roach says. Members of angel networks are committed to making investments on a regular basis, and may also syndicate deals with other networks (e.g. an Austin angel network may talk to a Houston network and invite them to join on a deal). That can help entrepreneurs shortcut some of the conversations and pitching.
At the end of the day, businesses should be aware that equity under the new SEC rules means bringing on investors that may be with you for years, Roach says.
“Companies that will do crowdfunding well are those who will understand that,” Roach says. “They’ll make relationships that help the business. Those who will get into trouble are those who will disregard those relationships.”