Can Rewards-Based Crowdfunding Help In Solving Issues Facing Founders Of Startups?

Joseph W. Bartlett, Council, Reitler Kailas & Rosenblatt LLC

You might be interested in a methodology for solving issues which confront the founder or founders of an early stage (the garage version) emerging growth company as the company launches.

The idea, which occurred to me while speaking to an event sponsored by the Crowdfunding Professional Association (“CfPA”) in DC, involves a dual approach for raising money, combining a pitch for donations under the rewards-based crowdfunding networks and platforms, the most prominent being Kickstarter and Indiegogo, with conventional fund raising under the auspices of Regulation D, Rule 506(b).

Many early stage high growth aspirants stumble because they don’t have enough money in the bank to cover their organizational expenses and therefore, the efforts to raise a Series A Round under Rule 506(b) do not get off the ground, so to speak. There are service providers I am acquainted with which will chaperone an emerging growth company through the rewards-based phase and, of course, there are a variety of intermediaries which can help with the Rule 506(b) offering.

I have not, until very recently, imagined that the organizational money (given, of course, an unusually attractive business model) could be raised alongside or immediately followed by a Rule 506(b) solicitation. The realization that it apparently can happen … because the only offering of securities is the Rule 506(b) process … means that, selfishly, there may be money in the bank to pay some kind of retainer and to cover legal fees of a law firm which (like ours), is skillful in helping founders launch on the trip, as I put it, “from the embryo to the IPO” (or to a trade sale).

According to a service provider in both rewards-based and Rule 506(b) fund raising, not only is it a way to attract the development money needed to pay the legal and marketing costs associated with a larger raise but it is an opportunity for startups to show some traction with initial customers, … which can help the ventures be more attractive to investors in the next round. Additionally, this approach allows entrepreneurs to get some early product feedback from those who support the rewards campaign, which can also result in refining and improving the product so it’s stronger when seeking the bigger dollars. My source says there are a couple of famous venture capitalists who say they will not even consider investing in a venture until it has a “crowd round,” as the rewards-based campaign can be so integral to launching with a better product and one with traction.

Next, to every pitch idea there is, of course, an adjacent caution. Thus, another source of information for this piece cited the recent Oculus story, where the rewards-based supporters who provided $2 million of early capital got precisely what they were promised (a set of goggles), but did not participate in the $2 billion payday enjoyed by  the entrepreneurs and VCs who bought securities in the Rule 506(b) rounds. There has been much angst and criticism in the crowdfunding world about this. [1]

The two prong strategy, in short, probably needs to be approached carefully. If the startup is robust enough that the Series A round is “in the bank” so to speak, a contemporaneous or immediately preceding donation -based round might label the founders as cynics … finding cheap money wherever suckers can be located. That said, in the undersigned’s experience, a large majority of the early stage founders in the U.S. are looking down a long arduous road before the Series A is “in the bank.” The Occulus result looks like an extreme outlier. The better idea is to get enough rewards-based money to join with the founder(s) blood, sweat and tears, enabling the process to pay something to the lawyers, a retainer (maybe) to a placement agent and the startup expenses of traveling the long (typically) road to a closing on the A Round. The service provider mentioned above likes to cite a Smart Thing as a good example, “With an initial goal of $250,000 on Kickstarter, it raised $1,209,424 on the platform and then raised an additional $15.5 million in venture capital and sold to Samsung for $200 million in August 2014.”

Time will tell whether a two-step sequence is the way to go.

[1] See, e.g., Prosser, “Does Facebook’s Deal For Occulus Spell Trouble For Kickstarter,” April 2, 2014, Forbes.com

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