New Crowdfunding Rules Bring New Opportunities

Economic crises can reveal a lot about established companies.

Are they nimble enough to pivot? Can they come up with creative solutions to adapt to a new environment? Was the company prepared for an emergency?

Apple and Google were sitting on a pile of cash. They were definitely prepared for a crisis.

GM figured out how to help produce masks and ventilators. Amazon designed a clever system for people to shop Whole Foods online and get the groceries delivered to the trunks of their customer’s cars.

And Boeing managed to get a bailout. OK. That was a cheap shot. But still, you get my point.

An economic crisis also reveals a lot about startups. Truly outstanding startups will find a way to survive and thrive during tough economic times. Many of the country’s top companies, including Microsoft, Burger King, GM, Hyatt, Mailchimp, Uber and AirBnb, were started during recessions.

There’s a reason why startups that survive recessions become truly great companies — and investments. Early-stage startups are particularly vulnerable during tough economic times because they are just learning to crawl.

And these times are tougher than most. This recession will force most weaker startups out of the market. If startups can survive and thrive in this environment, they’re truly special.

But even strong startups can use a helping hand. There’s no way they could have planned for the COVID-19 pandemic. That’s why the government announced last week they’re adopting temporary rules that make it easier and faster for startups to launch small equity crowdfunding raises. In fact, some startups can launch raises in a matter of days.

The three key features in these relaxed rules are:

  1. Only startups that have done crowdfunding raises in the past can take advantage of these new rules.
  2. Startups can begin their raises without releasing financials.
  3. Startups are not allowed to transfer raised funds to their bank account until they release their financials.

So how does this work in practice?

First, a startup has to convince an investment platform or portal like SeedInvest, Republic.

Then, it has to decide how much it’s raising. For now, startups can go down one of two roads. Companies that are raising less than $250,000 will have to issue self-audited financials before the raise ends. That’s much bigger than the $107,000 previously permitted.

Startups raising up to $1.07 million (the maximum allowed) can submit audited financials before the raise ends.

But remember — these startups can begin their raises and start accepting commitments to invest before they submit their financials.

The emergency rules seem mostly intended for seed-stage companies. And, sure, a lot of them are pre-revenue. But without a company’s financials, you don’t know what questions to ask. Or how long a company can keep going with a new infusion of cash.

Was the company spending a lot before Covid-19 hit? Does its progress depend on a high level of spending or can it significantly reduce costs and still forge ahead?

These are key questions that need answering. And you can’t do it without financials.

If the startup is trying to raise $210,000 but spends around $70,000 a month, that money will last just three months. What happens then? Is that an investment worth making? Many investors will consider it a tough ask, even if the company has a great product and high upside.

It’s not all bad for investors though. In fact, I think these new rules provide an excellent opportunity to go bargain hunting for high-quality startups.

Valuations should drop significantly as the economy struggles to get on its feet. Startups won’t want high valuations to stand in the way of investors writing them checks. You’ll be able to invest at discount prices.

With more startups raising, there will be more great opportunities than usual. And more bad ones. It’s a great time to invest in seed companies… but only if you’re careful.

And, collectively, crowdfunders usually are. They ask founders tough questions. These aren’t presidential debates. If the answers are inadequate, they’ll ask again. So make sure to read the Q&A section of portals. It oftentimes has the best insights.

I don’t usually invest in companies desperate for cash. But these are unusual times. And founders can’t be blamed for not preparing for the unpredictable. COVID-19 arrived with little warning. If these founders now need money from you to keep their startups going, it could be a nice win-win for both you and them.

It’s now or never. I’m willing to do a little extra work to find the gems selling at a discount. Because when these new rules end, some terrific opportunities will go away.

(Click here to read more about the new SEC regulations.)