One of the most important features of investment crowdfunding is the ability to encourage an investor to invest by offering incentives. An incentive may take the form of a premium, a free or discounted product or service, or an opportunity to upgrade an investment at a later time.
Incentives are of particular importance to those businesses, social enterprises and community projects that may never earn big profits or attain high share values. These capital seekers will never compare favorably with ‘gazelles’ and ‘unicorns’ – terms given to high growth, high profit businesses, that can offer investors a high rate of return on their investments. When comparing the ROI on different investments, the capital industry is like any other commodity. The highest price will go to those businesses that can pay the highest rewards. All ‘average’ businesses, or those that put a social outcome ahead of profits, must offer alternative benefits or value to attract investors.
Incentives are also important to business owners who need money to grow, but do not intend to ‘flip’ their business and sell it off after all of the hard work to get it started. Instead of selling a startup at the end of 3, 4 or 5 years, the owners desire to operate the business to fulfill its mission (which is not to make the owners rich). Without a sale, it is difficult to create a ‘cash exit’ and payback investors. These businesses must also offer alternative benefits or value to attract investors.
If the business is able to offer large enough incentives, it will change the focus of the investor away from the future, unknown rate of return on the investment to an immediate, tangible gratification. By shifting this focus, the business may not only be able to gain the investment, but it may also be able to reduce the price of the money received through the crowdfunding campaign. It may offer less stock for the same price, a lower interest rate on a promissory note and/or a lower royalty rate on revenue sharing. The tradeoff between the total aggregate costs of all incentives and the reduction in price of money deserves significant consideration by the business.
Incentives are not new. One of the most common is a convertible note. An investor is offered a promissory note as the investment. However, if the business performs well and its stock value goes up, the investor may convert from the note, a debt instrument, to a stock, an equity position, that can appreciate with the success of the business. Similar incentives may include warrants to buy more stock in later offerings, which warrants may be discounted from later offering prices.
It is anticipated that most investment crowdfunding incentives will be centered on the products or services of the business. This concentration is due to the fact that the customers of the business will likely be the single largest group or crowd that will benefit from the success of the business. Customers, having the most to gain, are the best candidates to become investors.
The design of an investment incentive tracks with the design of a new product or service. Will it achieve the primary objective of obtaining an investment? Is the benefit obvious? Will there be a net benefit to the business in that the cost of the incentive does not exceed the amount of the investment? Can the incentives be matched to different types of investors with different reasons to invest? Are there incentives that can be matched with different levels of investment – small dollars as well as large dollars?
There is a cost to every incentive. Like a bank giving away a new toaster for opening a new account, the bank has to front the cost of the toaster. If the incentive is purchased from a third party, each investment will require an outlay of cash. If the incentive is a product or service of the business raising money, each investment will impact the bottom line of future operations. Discounts on products or services up to the gross or net margin, will create a ‘push’ where the business neither makes nor loses money. Lesser discounts actually serve as a form of a sale with the business making money at lower margins in addition to the investment. The impact of incentives on current or future cash flow should be taken into consideration.
The value of the incentive may be viewed as an immediate return on investment to the investor. If the investors invests $100 and gets $10 in products, the investor is realizing a partial payback on the investment. The net investment is only $90. Future distributions to the investor will cause the investor to reach a breakeven on their investment earlier and start realizing returns.
Where the value of the incentive is indirect, the impact of the incentive may be substantially reduced. If an urban farmer commits to give away 10 pounds of produce to a local charity for each investment, the farmer must track and publicize the gift to the investor. This might take the form of making the gift to the charity in the name of the investor with a photo of the event.
When offering incentives, the business must be clear as to its ability to deliver the incentive and when that delivery may be completed. If the business is dependent upon raising money from the crowdfunding campaign in order to be capable of manufacturing the product, this fact should be stated in the crowdfunding offering documents.
The design and offering of investment incentives will be one of the topics in the upcoming half day workshop on Customer Crowdfunding presented by the Colorado Capital Congress at Colorado Lending Source on December 10. http://www.coloradocapitalcongress.com