This post, written by Mark Graffagnini, originally appeared on graffagninilaw.com.
The best companies today have loyal customers. Many companies offering Software as a service (SaaS) platforms or even offline memberships have thousands of loyal customers. More and more, these companies are turning their customers into investors.
Dinner Lab is probably the most high profile example to date of a company using crowdfunding to turn its current members into investors (full disclosure: my law firm represents Dinner Lab in its offering). I believe that many more companies will take path of “customer crowdfunding.”
Certain legal changes brought by the JOBS Act make it possible to turn customers into investors. These new rules can be tricky, so you will want to put a clear procedure in place before you offer your current customers the chance to invest in your company. A few tips are listed below.
What are the advantages of customer crowdfunding?
- Customers often understand your business better than investors you don’t know.
- Individuals will often give you better terms than VCs or even angel groups.
- Having a wide base of different types of investors may mean that a single voting bloc does not emerge, allowing you, as the entrepreneur, to retain more control over the company’s direction.
- If our experience shows anything, a general solicitation to your customers can significantly boost the company’s profile in the press and media.
What are some disadvantages of customer crowdfunding?
- New rules require that you verify that your investors are accredited and have enough wealth ($1M in net worth or $200K in income, $300K with a spouse) if you use “general solicitation” to announce the investment opportunity. You need a clear procedure in place for this and will need to be guided by an experienced lawyer.
- Lots of shareholders means you need a tight corporate governance and there might be some costs associated with that.
Overall, the advantages of customer crowdfunding may outweigh the disadvantages. If you decide to pursue this strategy, then here are some tips to keep in mind:
- Decide whether you will use general solicitation to announce the financing publicly.
- Start off with an email that is fairly generic and does not discuss too many details about the deal.
- Ask employees to fill out a questionnaire about their interests and financial situation.
- Have management follow up with the potential investors to determine if they might be a good fit.
- Consider whether you want investors to sign a confidentiality agreement before you share any sensitive info.
- Request a letter from the investor’s accountant, lawyer, stockbroker or financial adviser certifying that the investor is “accredited.”
- Provide a disclosure document such as a private placement memo.
- Get the money!
As the market becomes more familiar with customer crowdfunding, it will become a useful tool for companies seeking to raise money from investors who already like your company. Companies looking for a cutting edge financing and PR tool can take advantage of the fact that only a few companies have so far taken advantage of this new strategy for financing.