There are three general offerings and variations that are common when companies choose equity crowdfunding as their strategy to raise capital.
Debt – Amortizing Loans
Equity crowdfunding does not mean you can only issue equity. Companies may offer a loan with attractive terms to investors. The good news with a loan is that issuers are not selling ownership (equity) in their company. The bad news with a loan is that the issuer must pay it back whether they’re doing well or not. Cash flow must be sufficient to make the monthly loan payments which makes these types of loans very similar to what a business might expect from a bank.
Debt - Revenue Based Loans
Revenue-based loans have become popular over the past few years, especially among those using equity crowdfunding to raise capital. Revenue based loans are well-named in that the repayment of the loan is tied to the borrowing company’s ability to generate revenue after investing the funds it raised. They simply use a portion of that revenue generated to pay back the loan. Repayment to the investor comes off the top and the investor usually receives back more than they initially invested, typically 1.5x to 2.0x their investment, depending on the terms of the offer. These loans work well for companies that have existing operations and revenue. Since repayment is not tied to a fixed monthly amount, it may take months or years to pay back, but on terms that make it worth it for the investor no matter how long the repayment term.
Equity – Straight Equity
Shares of a company can be sold via equity crowdfunding now that North Carolina has passed the PACES Act. The issue here is to agree on a valuation – what the company is worth, from which the price per offered share is determined. The problem with valuation of privately held companies is that calculating the value is an inexact science. Even among sophisticated, accredited investors, valuation is a moving target and seldom is there quick consensus on what the valuation should be. In addition, even if there was a good way to place a value on the company’s shares, there currently exists no secondary market by which to sell your shares.
Equity – Simple Agreement for Future Equity (SAFE)
An increasingly common way around the valuation challenge is to offer a Simple Agreement for Future Equity security (read this SEC bulletin about what to watch out for regarding SAFEs). SAFE agreements are commitments to give future equity in the company when certain specific events occur in the future. These events can include the raising of more equity, the issuing of preferred stock, or even the sale or merger of the company with another. A SAFE offering can be advantageous because it allows an issuer to raise equity quickly without having to spend weeks or months haggling over a valuation that will define the deal in which investors will participate.
Hybrid – Convertible Notes
Convertible notes are like SAFEs, however, they start off as debt (“a note”) and are “convertible” when certain events occur or milestones are reached. Events such as raising a Series A round or the company being sold or merged would trigger a conversion. When these events occur, the investor has the right to convert the money they invested into shares at a discounted rate that’s predetermined in the terms of the note. Or the investor may choose not to convert and keep their investment as debt. There is usually a maturity date defined in the future at which time the note must be repaid or converted into stock. This decision is usually the choice of the investor. Like SAFEs, convertible notes allow companies to offer an equity security without having to negotiate the specific valuation of the company.