Growth Companies Benefit From Final Crowdfunding Rules

December 8th, 2015 | Posted by Sarah Jones in Guest Blogs - (Comments Off)

This week on NVTC’s blog, Alex Castelli of NVTC member CohnReznick shares how the SEC’s adoption of new crowdfunding rules could be a game changer for growth-focused businesses and investors.


The SEC’s adoption of new crowdfunding rules could be a game changer for growth-focused businesses and investors

On Oct. 30, 2015, the SEC approved final rules that permit companies to offer and sell securities through crowdfunding. The new rules provide another capital raising option for growth-oriented companies and offer additional options for investors who want to get in on the ground floor of in what could be a very successful business.

Benefits to Companies and Investors

Some of the key benefits of the SEC’s rules permitting crowdfunding or, simply put, the ability of companies to raise capital from the general public through the Internet are listed below.

  • Early-stage and growth companies that may be unable or unwilling to raise capital from institutional or private investors have access to another source of capital.
  • By offering and selling equity in their company through the Internet, companies gain a wider and more efficient distribution of the offering to a larger audience when compared to traditional sources.
  • Using the Internet to offer and sell securities should decrease the cost of capital
  • Non-accredited individual investors, previously excluded from equity crowdfunding investments, are now invited to become investors with certain limitations.
  • Investors have a level of protection since companies raising capital through crowdfunding will be required to utilize funding portals or registered broker dealers and will have certain disclosure requirements to investors. Additionally, funding portals that wish to participate in the crowdfunding process as an intermediary will be required to register with the SEC and become a member of FINRA.

Launching Your Crowdfunding Campaign

Even if you are a tremendously successful owner or executive, a successful crowdfunding effort will require expert marketing surrounding your efforts to raise funds. You and the members of your management team will assume the responsibility of formulating a marketing campaign to create interest in your offering. You’ll need a good story to tell investors complete with business plans, financial statements and projections.

In the crowd, you’ll be competing for investment dollars with other companies so you need to engage in strategies to elevate your offering over all others. Earning the trust and confidence of investors can lead to a successful offering. Consider activities that could strengthen your relationships with clients, customers, and even vendors. These relationships may help to support a successful crowdfunding campaign and could represent your future investors.

To launch your crowdfunding campaign, you’ll be using the services of an SEC registered broker/dealer or SEC registered crowdfunding platform or funding portal. Each will probably offer different services and fee structures. Once your customers, clients, and vendors have invested in your business, you may want to reach out to a broader base of potential investors. Getting your offer in front of the right investors will be critical to achieving your capital raising goals.

As a private company, you may not be accustomed to sharing operational and financial information publically. A successful crowdfunding campaign may require additional transparency if you are to build trust and confidence in prospective investors. If you are not comfortable sharing company information with the world, you may want to explore a more proprietary method of raising capital.

Once you have executed a successful crowdfunding campaign, you will need to have a plan on how you will continue to communicate to your new investors. How much information are you willing to share? Which rights to information will investors have? Consider creating an investor-only section on your company’s website where you can post periodic information about your company’s progress, financial results, etc. Transparency is the key if you want to keep your investors informed and hungry to make additional investment in the future.

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NVTC is inviting members and industry leaders to serve as guest bloggers, sharing insights and information on trends or business issues relevant to other members. In his second post on the NVTC blog, Matt Rajput of CohnReznick shares his insights on new methods for valuing technology companies.

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As the IPO market continues to churn and with plenty of money on the sidelines, could it be that investors are changing their models for valuing a technology company?

In recent years, a company’s top line revenue and projected growth carried significant weight in attracting interest from investors as evidenced by valuation multiples of 5x, 10x, even 20x. However, we’ve recently seen that an increasing number of investors are taking a closer look at “marginal gross margins,” which is defined as a new dollar of revenue minus the cost of producing that revenue as the company grows.   Simply put, this measurement identifies the cost incurred in earning another dollar of revenue.

Calculating marginal gross margins has become a more popular method of calculating the value of a technology company because it is considered a cleaner look at operational efficiency, which is often challenging to measure in acquisitory companies that actively buy customers and market share to drive growth.  Some investors feel that buying customers and market share through acquisitions is not a favorable long term strategy for solid growth.  What happens when customers become more challenging to find and the next couple of deals fall through?

To me, it doesn’t make sense for investors to acquire a company that spends a dollar to earn a dollar in revenue, even if revenues increase by millions of dollars resulting in impressive top-line results.  A few months back, the $19B valuation of WhatsApp seemed outrageous to some, but when industry analysts began to dig deeper into the numbers, it came to light that WhatsApp had a very high operating gross margin. Coupled with its ability to grow as a cutting-edge technology, the sustaining membership revenue cash flow, and the sizable market cap, this valuation seems more reasonable.  WhatsApp passed the sticky test with flying colors!

Stickiness usually leads to higher gross margins.  The better that a technology company can become engaged with its current client base, the greater the opportunity for increasing gross margins and in turn the more positive an impact on the valuation of the company.  So, as an alternative strategy to building value, technology company decision-makers may want to think twice about buying that next customer or company and instead develop new and engaging products and services that contribute to the organic growth of their customer base.

If you’re a technology investor or a technology company decision maker, I’d be interested to hear your thoughts.

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Matt Rajput, CPA, is an Audit Manager with CohnReznick LLP and a member of the firm’s Technology Industry Practice. Working from the firm’s Tysons Corner office, Matt has eight+ years of experience servicing publicly-traded and closely-held companies in the technology sector and he routinely provides services to private equity and venture capital backed companies. Contact Matt at matt.rajput@cohnreznick.com.

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