Think Twice About a Low Target Amount in Title III Crowdfunding

Target amount in Title III Crowdfunding

Many Title III issuers are setting “target amounts” as low as $10,000. I understand the motivation, but I’d urge issuers and the platforms to think twice.

Background

In Title III Crowdfunding (also known as “Regulation Crowdfunding” or “Regulation CF” or “Reg CF”), the issuer establishes a “target amount” for the offering. Once the offering achieves the target amount, the issuer can start spending the money raised from investors, even while continuing to raise more money. That gives issuers a strong incentive to set a low target amount.

EXAMPLE:  A brewery needs to raise $400,000 for equipment, fit-out, marketing, and salaries. If the brewery establishes $400,000 as the target amount, it can’t start spending the money from investors until it raises the entire $400,000. If it establishes $10,000 as the target amount, on the other hand, it can start spending investor money as soon as it raises the first $10,000 — even if the business will fail without the full $400,000.

The platform benefits, also, in two ways:

  • If the brewery establishes a target amount of $10,000 and raises at least that much, the platform can include the brewery in its “Reached Target Amount” list, even if overall the brewery raised only $12,000 and failed.
  • The platform receives a commission only on funds released to the issuer. The sooner money is released to the issuer, the sooner the platform earns a commission.

Minimum Offering Amounts

Target amounts were around long before Title III Crowdfunding, in the form of “minimum offering amounts.” A company raising capital would establish a “minimum offering” equal to the lowest amount of money that would make the business viable. If a brewery absolutely needs $400,000 to be viable, then the minimum offering would be $400,000. If it could plausibly scrape by with $315,000 — maybe by deferring the purchase of an $85,000 piece of equipment — then the minimum offering would be $315,000.

Issuers don’t establish minimum offerings because they want to, but because experienced investors won’t invest otherwise. If $315,000 is the minimum that will make the brewery successful, an experienced investor writing the first check will demand that her money be held in escrow until the offering raises $315,000. If the offering doesn’t raise $315,000, she gets her money back. Investing is hard enough:  why invest in a company that’s guaranteed to fail?

That’s also why we have traditionally seen “minimum/maximum” offerings. The brewery that needs at least $315,000 to be viable might be able to make great use of up to $475,000, with both numbers anchored to a believable business plan.

The Decision in Title III

Cash is king for most entrepreneurs, the sooner the better, so a Title III issuer will be tempted to establish a low target amount. And to the extent an issuer can rely on inexperienced investors, it might be successful, at least in the short term.

But the issuer should also be aware of the downside:  by establishing a low target amount, the issuer is driving away experienced investors. How many experienced investors are driven away, and the amount they might have invested, can’t be captured.

On the positive side, an issuer that establishes a realistic target amount can and should advertise that fact in its Form C, perhaps drawing a favorable contrast vis-à-vis other Title III issuers, whose target amounts were picked from the air. That’s the kind of information an experienced investor will like to see.

An issuer that weighs the pros and cons and nevertheless decides on an artificially low target amount should include a prominent risk factor in its Form C:

“The ‘target amount’ we established for this offering is substantially lower than the amount of money we really need to execute our business plan. If we raise only the target amount and are unable to raise other funds, our business will probably fail and you will lose your entire investment.”

Artificially low target amounts carry a long-term downside for the platform, too. I would argue that as long as issuers are establishing $10,000 minimums, Title III won’t be taken seriously as an asset class, and the industry won’t grow.

Questions? Let me know.

4 thoughts on “Think Twice About a Low Target Amount in Title III Crowdfunding

  1. Mark,
    Excellent article!
    There is another very important reason for an issuer to re-think accepting investments with too low an offering minimum. We worked with a client to finance a Broadway show under Reg CF, but they were not successful. They argued that they “just wanted to get some money to get going” but we advised against setting their minimum too low (at $10K). We set a $50,000 minimum for several good reasons. First, and perhaps most importantly, if they had gotten their $10,000 and that’s all, how could they ever cover the costs for reporting to their shareholders in the future? The good news was that since they did not reach their goal, they would not have new shareholders to file and report to under Reg CF rules. It’s a huge problem for companies that must report if they have no money. The second reason we suggested setting their minimum at $50k is that they would then have at least a little marketing money to propel them to the next level. We have seen companies “walk their way up” to their goal by using part of the funds they receive as it comes in to pay for continued marketing. So we are in complete agreement for these reasons not to set your goal too low, or you will have no marketing money and also be too poor to comply with the rules in the future.

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