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Crowdfunding: The Challenge of Selling Private Securities [Part 2]

Crowdfunding: The Challenge of Selling Private Securities [Part 2]

Selling Private Securities

There is nothing easy about selling private securities. But, long before the hard road of selling is taken, the CEO must erect the entire marketing and regulatory framework. The marketing and sales of the securities must fit into the legal and regulatory framework. If that framework in built, then Verdonik suggests that the CEO can begin internet selling activities.

Verdonik begins the discussion of selling securities with his detailed analysis of the components of the capital markets that make deals happen. Verdonik calls one of these parts of the market the deal-makers, or in the case of accredited investor crowdfunding, the “Little Dogs.”

The little dogs are the range of business professionals who put the deal together and then bring the other two components of the market together, the buyers of capital, and the sellers of capital.

Verdonik suggests that deal makers include:

  • Venture capital and angel capital firms
  • Investment banking firms that assist in mergers and acquisitions
  • Business brokers and valuation consultants
  • Finders of investors who may be interested in investing in a deal
  • Real estate developers who place the private companies into office buildings and industrial parks
  • Firms that operate website platforms and conduct social media marketing to attract investors
  • Traditional FINRA broker-dealers, who distribute securities to their retail investor clients

In addition to deal makers, Verdonik identifies another set of licensed professionals who offer professional ancillary services to the other 3 parts of the capital market. These professionals are:

  • Patent and securities lawyers
  • Engineers and scientists who investigate the claims about a product or service
  • CPA’s and accounting firms that prepare financial statements and analyze the integrity of statements
  • Marketing and public relations firms that assess the potential market demand of a product
  • Investment advisors who give advice to the CEO on how to manage an offering

In his statistical analysis of technology innovation, Professor Ed Feser, of the University of Illinois, uncovered evidence that this last group of licensed professionals contributed the most economic value to the entire process of technology innovation and commercialization.

Initially, Feser could not tell exactly what this other group was in his statistical analysis, so he grouped it together as a new part of his nine primary “technology clusters, and called it the 10th technology cluster. Upon further investigation, Feser decided to call this 10th technology cluster the “technology knowledge” cluster.

The role of the knowledge cluster becomes even more important in the Rule 506(c) for selling securities. Those professionals function to coordinate the deal makers with the internet search engine marketing firms. In other words, while the capital markets have 3 components: buyers, sellers, and intermediaries who do deals, the knowledge professionals act as intermediaries between deal makers and internet marketing firms.

Verdonik spends a great deal of time and space describing how internet social media marketing fits into the selling strategy of the CEO. He compares the current importance of social media marketing to the importance of “who-you-know” marketing in the older venture capital model. In other words, in the new accredited investor crowdfunding model, it is not who you know that is most important, it is how you know where you go to sell your securities.

Verdonik begins with the “Who You Know” and social class connections of the older model of raising capital because those are the parts of the market that are being disrupted by accredited investor crowdfunding social media marketing. He states, “Technology is making who you know how to contact and knowing how to communicare your story more important than who you know whey you begin your offering.”

Verdonik explains that CEOs need to sell their securities to their “affinity” groups that have some reason to like the company, and that these affinity groups contain likely investors. However, just because the CEO can identify affinity groups, and just because social media marketing can find these latent groups on the internet, the CEO must still “sell” the securities to members of each affinity group.

The CEO uses social media marketing as both a communications tool to tell her story to members of the affinity group, and as an advertising media to attract latent investors, who knew nothing about the company, prior to the public solicitation.

Once the CEO finds a potential investor, the CEO does something revolutionary and unheard of today. The CEO picks up the telephone and calls the potential investor, and makes a sales pitch. Just like a young stock broker who cold calls an investor to push the hot stock of the day. Drastic steps indeed.

As Verdonik asks, “Why would selling securities be any different than selling other products?”

He breaks down the barriers that a CEO confronts in using social media marketing to find an investor to sell the securities to.

How will investors find your offering on the internet?Will investors carefully sift through thousands of offerings?Do investors have better things to do with their time than looking at your offering?

The front end of social media marketing is creating bonds of affiliation with potential investors, so that when the CEO calls them, the investor already feels a warm glow about the company.

Verdonik lists the main parts of the social media advertising campaign strategy as:

  • LinkedIn
  • Twitter
  • Facebook
  • YouTube
  • Blogging
  • Company website
  • Third Party Profile listing websites
  • Investment communication applications

The main idea is to use the components of social media marketing to tell a compelling story about the company and the potential investment, as seen through the eyes of the potential investor. The CEO must become really good at telling this compelling story everywhere she goes, and once she starts telling her story, she can not change her story.

Verdonik makes this important point about how the CEO tells the social media compelling story. The compelling story about the securities offering is different from the compelling story about the product or service of the company. Verdonik states that the “commercial product offering sales message is separate from the investment sales message.”

The Cost Of Selling Private Securities

In the older venture capital method, where the CEO went from firm to firm seeking a venture capitalist to buy the securities, the CEO did not absorb many out-of-pocket costs to raise capital.

In the new accredited investor crowdfunding model, the CEO absorbs front-end, out-of-pocket costs to sell the securities, similar in nature to the costs of selling the products of the company. Verdonik breaks down these front end costs into different selling categories, which is very helpful to the CEO in planning and budgeting for the capital raise.

As he notes, the costs are incurred at various stages of the raise, and can be paid out of current company cash flows, with careful planning and budgeting. Some costs are incurred on the day of escrow closing, and are not out-of-pocket costs, but are deferred expenses related to selling the securities.

One cost he did not mention, because it is not a cash outlay, is an economic concept called the opportunity cost of time that the CEO has in selling securities versus some other activity. I estimate that in the first three months of planning for a Reg D Rule 506(c) offering, the CEO will spend about 3 hours, every day, seven days a week, getting the offering strategy in place.

During the six month offering period, the CEO will spend every day selling the securities and dealing with issues related to the offering.

After the offering, the business life of the CEO will never be the same. The CEO will have on-going disclosure and financial reporting related to the securities that never end.

Verdonik takes time to explain the expenses for all the types of accredited and non-accredited capital projects, but this review only covers the expenses he describes for Rule 506(c) offerings. In a 506(c) offering the are fees related to marketing the securities, fees related to legal and accounting services, and fees related to commissions, if a broker/dealer is retained to distribute the securities.

For marketing fees, called social media fees by Verdonik, he estimates a range from $0 to $50,000. These costs are incurred all along the way, but many of them are front-loaded, at the beginning of the project. The rule of thumb for an accredited investor crowdfunding project that I use with CEOs for marketing expenses is about $25,000.

Legal fees and accounting fees to get the financial statements in order are estimated by Verdonik to be between $10,000 to $40,000. I estimate that it takes an attorney about 60 hours of time to prepare the offering documents. If the company is a mess with its financial statements and record keeping, the attorney will spend more time to get the business house in order.

I think the minimum cost for legal fees is around $15,000, if the company is in good shape with its record keeping and financial statements. Usually, the attorney will want 1/3 of the fee on the day the letter of engagement is signed, 1/3 about half way through the project, and the rest at the end of the project. In some cases, the attorney may agree to defer the last payment until the day of closing.

Brokers will charge a contingent fee, paid on the day of closing, from the capital raised, of between 5% to 10% of the capital that they were directly responsible for raising. This fee is negotiable, but just like real estate commissions that are always around 6%, the “success” fee of a broker is always around 6%.

If the CEO retains an investment advisor to provide advice and to manage the offering, the fee for the advisor is usually 3% of the capital raised, paid to the advisor on the day of closing. This fee is also negotiable.

A new development related to fees for a capital raise is combining a business to business lending component to the front end of the raise to finance the expenses of the raise. On the day of closing, the business loan to the lending crowdfuning website is paid back.

How To Use Verdonik’s Book

The contents of this book are essential as a reference tool and a teaching tool. Verdonik is a gifted teacher and has a deep philosophical commitment to teaching what he knows about securities law. He is a rare person in that he combines being a scholar, a teacher, a constitutional and securities lawyer, and most importantly, a shrewd business advisor.

The hard copy paperback edition of this book is $43. I recommend that every securities law professor, every FINRA broker/dealer compliance officer, and every securities regulator buy a desk copy and keep it within arm’s reach.

The ebook edition is only $9. I recommend that every CEO, every public relations marketing firm, every FINRA regulated agent, and every possible intermediary buy the ebook and read it.

I have read most of the books about crowdfunding, and have even written a 200 page book about accredited investor crowdfunding, myself, that is only half as long, and half as good as Verdonik’s book.

Like most stocks that I investigate, I know a good book when I see one, and this is a terrific book.

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  • Guest QuickLiquidity Mar 12, 2016 08:25 pm GMT

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