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What the New Reg CF Limit Means for Founders

What the New Reg CF Limit Means for Founders
By Andy Gordon
Date November 5, 2020

I’m doing something different today. I want to give founders some advice. I’ve been alerting every founder I talk to about this. And I’m shocked that just a handful of them are aware of the biggest boon that has come their way in a very long time. So, I’m using today’s post to reach out to all the founders out there with some great news.

The SEC has given you a wonderful gift — a gift potentially worth millions. It officially announced this week that starting in 2021 you can raise up to $5 million from retail investors — people like you and me (some people call us crowdfunders)! The max founders could raise used to be $1 million. 

This is terrific news (with one exception)! Let’s start with the good news. 

  • You’re still the boss. Founders who need capital go where the money is. Traditionally, that’s venture capital. But VC comes with a cost. Founders often have to give their lead venture capital investors a seat at the table. That can mean making them an advisor, part of the startup’s executive team or giving them a seat on the board. Many founders don’t like this arrangement. They value their independence and trust their own judgement. As a matter of fact, when I ask founders why they are crowdfunding, the majority say they want to maintain control of their company. The downside has always been they could only raise $1 million under Regulation CF rules — a tiny amount for a growing startup. That disadvantage goes away in January. 
  • You’re saving a boatload. Reg A+ raises have allowed founders to raise much more money than Reg CF. But they’re also expensive to organize — the costs for lawyers, accountants and the portals adds up. They end up spending roughly $100,000 just to hopefully find new investors. Reg CF (crowdfunding)  cuts those expenses by more than half. That’s a big deal if you’re a tiny and/or bootstrapping startup where every penny counts. With the new $5 million limit, founders can save valuable resources without sacrificing their ability to raise more capital.
  • You’re spending less time raising and more time running your company. Founders aren’t lawyers or accountants or PR maestros — they shouldn’t have to be. But raising from VCs or under Reg A+ rules will gobble up your workdays poring over legal documents… checking and rechecking your financials… recalibrating your pitch on a daily basis…  and finalizing your 100-page plus SEC Offering Circular filing. Reg CF raises may have their own set of requirements — but they require much less work. And that leaves you free to focus on the really important matters in your startup.

The new max on CF raises looks like a sweet deal. But there is one downside. You’re selling a big piece of your equity at super-low prices. Let’s say you’re raising $1 million at a $10 million valuation. You’re giving inventors a 10% stake — not so bad. But raising $5 million at a $10 million valuation doesn’t make sense. You want to sell as much equity as you can later — when it’s more expensive. Luckily, there’s a way out of this dilemma. Founders can raise using a cap. Instead of raising $5 million at a $10 million valuation, they’re raising it on a, let’s say, $20 million cap. This usually means the $5 million gets converted at the next equity round. And founders get another 1-3 years to elevate their company’s valuation to $20 million. That’s very doable.

Founders should raise with the goal of their money lasting 18 months or longer. If that’s $2 million, that’s your magic number. If it’s $3 million, then go with that. It doesn’t have to be $5 million. The point is you now have options. You have a way to diminish funding risk. And if you still want to go the VC route, that’s fine — but now you have a choice. Founders should take advantage of their new and expanded optionality.

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