By Benjamin Pimental | Nerd Wallet
Raising money to start a small business has become easier with equity crowdfunding.
That’s when you publicly tap a big pool of investors who agree to finance your small business in exchange for equity ownership.
In the past, you had to follow strict, often complex Securities and Exchange rules for publicly soliciting investments.
But that changed with the Jumpstart Our Business Startups Act, better known as the JOBS Act, passed in 2012, which has made crowdfunding a viable option for starting a small business or raising cash needed to expand and grow.
Some of the key rules are still evolving, including one that limits certain types of crowdfunding investments to wealthier investors, referred to as “accredited investors.” There’s some debate on what the changes could mean, as a group of professors explained to NerdWallet.
Still, if you’re starting a business, and not too keen on applying for small business loans, crowdfunding is one way to raise cash.
But it can be a tricky process, says Jim Dowd, managing director of North Capital, a Salt Lake City-based investment advisory firm. That’s because, as with any process in which you’re trying to get people to finance a venture, you have to be convincing.
Dowd offers four tips to small-business owners:
1. Make sure you can explain your business clearly and concisely.
In fact, Dowd says you should be able to do it in a sentence. When you make your pitch to potential investors, he tells NerdWallet, “Distill your message to a one-sentence explanation.”
“If the company’s founder can’t explain what they’re doing, chances are investors are going to lose interest,” Dowd says.
Investors will zero in on a “relatively compressed description of what the company does,” he says.
And you have to be able to explain the market opportunity. It’s not enough to say that you can attract a huge number of users or customers, for example. “If things go swimmingly well and the company is a success, how big is the market the company is trying to address?” Dowd says.
2. Explain in detail what you plan to do with the money.
This may sound like a no-brainer, but Dowd says he’s come across small-business owners who say they’re trying to raise, say, $2 million. But when asked how they plan to use the funds, they’re not able to give a clear response.
“It’s not really well-thought-out,” he says, which is a surefire way to turn off potential investors.
3. Show investors respect.
Another no-brainer, but Dowd says some company founders become “very self-absorbed” and project the impression that “everything is about their company, and what they’ve accomplished and what they’re going to accomplish — and they view investors as a means to get there.”
“That’s a red flag for us,” Dowd says.
4. Don’t exaggerate.
Trying to woo investors involves a certain degree of salesmanship. But “you have to know how far you can push,” Dowd says.
“There’s a line between being an aggressive salesperson and fibbing about what you’re doing,” he says. “We want people who are going to be balanced and honest.”
Dowd cites the example of a business owner who claimed to have a contract with a buyer, but ended up not being able to show proof.
He said his firm caught another business owner who lied about being a Chartered Financial Analyst, or a CFA charterholder.
“It’s like lying about your academic credentials,” he says. “If you get someone who exaggerates routinely or stretches the truth or outright lies, that’s a kiss of death.”
Meanwhile, if you’re a small-business owner looking for new avenues to finance your company, crowdfunding could be a kiss of life. And the practice is poised to grow and evolve, Dowd says.
“Right now, it’s fairly early in the market,” he says.
The name of the game is still growth potential, he says: “The people who are most successful with raising money are companies that basically have a large addressable market.”
But Dowd adds: “We’re in the first inning of what’s going to be a long ball game.”
For more information about how to start and run a business, visit NerdWallet’s Small Business Guide. For free, personalized answers to questions about starting and financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page.