Pre-selling products and services is an increasingly popular way to raise much-needed startup capital. Early supporters can typically buy in advance and provide you with the funds necessary to cover your operating or development costs without requiring you to comply with complex securities regulations, conduct expensive and time-consuming legal filings, or seek out angel investors.
The Benefits of Pre-Selling
In most states, pre-selling a product or service (a practice known as ‘customer financing’) is not seen as selling a security, so federal securities laws do not generally apply—meaning regulators do not usually get involved. The key is to ensure that customers who buy only receive what they paid for, with no additional financial incentives being thrown in. In most cases, as long as a start-up remains within that guideline, they may solicit an unlimited amount of public funds without having to go through the securities registration process.
Crowdfunding sites that enable entrepreneurs to set up their company project and solicit money in exchange for products or services include:
Many entrepreneurs, however, opt to raise money directly through their own business sites, and do so with varying degrees of success.
Could You Actually Be Selling a Security?
Many states use a risk-capital test when determining whether or not a pre-sold product or service might actually be a security. The test focuses on whether a chance exists that the investor will lose money after they have invested in an enterprise with the expectation of a benefit. In other words, if they buy 50 shirts from you and never get them, they have lost money and the transaction could be viewed as a security in a risk-capital state like California (though, as of this writing, not in Colorado).
In states where the risk-capital model is not in effect, regulators typically take the position that your investors did not anticipate a profit or cash benefit when they bought the shirts, meaning the transaction would not be considered a security. For this reason alone, all entrepreneurs seeking presales should ascertain how a security is defined in their state.
Careful budgeting and planning are also important parts of a successful pre-selling campaign. When pricing goods and services bear in mind any associated costs such as taxes and manufacturing, packaging, and shipping expenses, so that you have a better chance of getting the capital you need.
Keep in mind that if your production schedule changes, you’ll need to keep investors up to date on any consequent delays. These people are customers, not family members who have lent you money under laid-back circumstances. You need to maintain high standards of customer service.
To discuss your startup’s funding needs and potential options, please contact Doida Law Group today. We will review your business plan, help you avoid potential securities violations, and provide counsel that can keep you on the right track toward success.