Is Crowdfunding Right for Launching Your Idea?

[#1]

Over the last twenty years, the internet has changed the way we do almost everything; so why should fundraising be an exception? Crowdfunding, as it’s known, is a term that describes a group of people coming together online to financially support everything from artistic ventures to fully-realized opportunities by entrepreneurs or businesses.

The concept is pretty simple: the person or group seeking investments sets up an online profile on crowdfunding websites such as Kickstarter, Indegogo or AngelList and then describes—in detail—the opportunity they’re soliciting funds for. At this point, anyone with internet access becomes a prospective investor.

While the process of raising small investments from a large number of investors isn’t new, crowdfunding differs from traditional models of financing because it has a strong social networking component built into it.

Crowdfunding can essentially be broken down into four models:

1. Donation model—investors make a financial donation without receiving any tangible returns
2. Reward model—investors make a donation in return for some sort of reward (either tangible or intangible)
3. Pre-purchase model—wherein the financial contribution is essentially a pre-purchase of the person/business’s product
4. Equity model—investors receive an interest in the profits of the business they are helping to fund

Using crowdfunding to help your business

Just how seriously should businesses take crowdfunding? According to Forbes, crowdfunding raised $1.5 billion in 2011, and is set to double that number in 2012.

In early April, President Obama signed the JOBS Act (an acronym for “Jumpstart Our Business Startups”) into law, a bill designed to help revive the nation’s economy and improve the unemployment situation. One part of this act worth noting is that it allows companies to raise funds by offering stocks or bonds to the general public. So, rather than donating, people are now allowed to invest in the companies they like. Crowdfunding has always been a way of raising money, but what this act does is allow business owners and entrepreneurs to raise up to $1 million from individual investors online and allow those investors to receive actual equity for their investment.

Taking advantage of crowdfunding’s benefits…

If someone sees enough in your product or service to invest in it before it is released, then there is clearly a demand for it. On the other hand, if there’s a lack of financial commitment prior to its release, then perhaps the demand isn’t what you had anticipated or your marketing message is off target. Regardless, this type of market research is an invaluable tool at such an early part of the process.

Crowdfunding also helps you create a built-in customer base. If people are willing to invest in your product or service once, chances are they’d be interested in doing it again. With a built-in customer base you also get word of mouth marketing. If the product or service you’re providing is good, your customers will tell people about it. And in the world of social media, where word spreads quickly, you can never have too much word of mouth. Similarly, these same customers could provide you with case studies and testimonials, enabling you to influence more customers to buy from you.

…and avoiding its risks

While the JOBS act is designed to help young companies grow and create jobs, it also opens the door to an increase in scams and risks for investors. In fact, the National Crowdfunding Association is already working with the SEC and other departments to ensure that crowdfunding doesn’t become a launch pad for scam artists.

It’s because of these potential scam artists that the crowdfunding model might eventually be tarnished to the point where investors will shy away from this method of investing. The best way to set investor’s minds at ease is to validate your product or service with as much up-front information as possible.

The JOBS act includes a set of investor protections—including the business plan, potential conflicts of interest, and current financial condition—but it will take some time for these provisions to be put into place.

Few investments are without risk, but crowdfunding can provide your business with much more than just financial funding. The possibilities of public online investing can ultimately lead to your company’s success.

This article was originally posted in HP’s Technology at Work email newsletter. Click here to subscribe today.

[#2]

Fascinating article and great information here. I think most people have seen this in the form of http://www.kiva.org/ type sites only.  This is where you help, usually folks in other parts of the world, who need very little money to launch a small business.  But the notion of using it under the JOBS program is a great idea for US-based startups and SMBs.

[#3]

Crowdfunding May Mean a Crowded House, as published in the Chicago Daily Law Bulletin on June 8, 2012

By:  Rita W. Garry, Esq.

As everyone who reads, listens, or looks around knows by now, President Obama signed the bipartisan-supported Jumpstart Our Business Startups Act (the JOBS Act) on April 5, 2012.  Among the many legislative initiatives covered in the JOBS Act (creates an “emerging growth company”concept to ease entry to the IPO marketplace; expands availability of Regulation A public offerings; raises Section 12(g) triggers for the Securities Exchange Act of 1934 (the ‘34 Act) reporting; and removing the general solicitation limitation from Rule 506) is Title III or the so-called “crowdfunding” exemption from the registration requirements of the Securities Act of 1933 (the ’33 Act), which directs the SEC to rulemake into existence a new Section 4(6) exemption from registration by December 31, 2012.  The stated objective of the JOBS Act and, in particular, Title III is to expand capital-raising opportunities for smaller companies without compromising investor protections, which are the hallmarks of the ’33 and ’34 Acts.

Title III authorizes the creation of exemption from offering registration the sale of securities to raise up to $1M in a 12-month period, provided the investors do not invest more than 10%, on the high side (with a $100,000 maximum), or 5%, on the low side (with a $2,000 minimum), of their annual income/net worth or, as I refer to it as, the “wealth test.”  Thus, if the full $1M is to be raised, then there will be a minimum of 10 new investor-owners, on the low end, and upwards of 500 on the high end.  At the outset, this investor qualification factor will be a verification challenge and data privacy concern. However, the greater challenge may be on-going administrative issues presented by holding investor-owner meetings, establishing quorums, preparing annual investor-owner reports, achieving applicable voting consensus for company sales, mergers, and other organic corporate events, and imposing transfer restrictions on such securities.  As I am sure many attorneys can recount numerous bitter business break-up stories with as little as 2 owners (who shrugged off the buy-sell agreement as a legal nicety), our role in educating business clients on the niceties of corporate law will now be exponentially greater.

While we will not know exactly how “crowdfunding” will work or the ultimate regulatory compliance that will be involved in executing such an offering until the rules come out, we do know the following to be true:

• The JOBS Act does not eliminate anti-fraud rules and all issuers and intermediaries must control communications for material misstatements and omissions.
• The crowdfunded offering will be subject to integration with other exempt offerings for compliance purposes.
• The issuers and the funding portals will be subject to SEC and FINRA regulation and oversight and the “bad actor” provisions of securities regulation.
• Annual reporting to the SEC and the investor-owners will be required, including, eventually audited financial statements.
• There will still be compensatory restrictions on promoters, finders, and other lead generators.
• The new investor-owners will have all the rights and remedies provided to stakeholders under the applicable business entity statutes and case law.

In the Entrpreneurs Unplugged section of Crains, Stella Fayman wrote on March 26, 2012 about the “startup crowdfunding bill” noting the entrepreneurial community should take advantage of this fund raising method and stated, “Right now if you can’t find angel funding or VC funding you have a couple of options: get it from friends and family, bootstrap or die- however, this bill will give you another option.  The JOBS bill will allow startups get investments of up to $1 Million dollars per year, from a lot of small time investors, in return for equity.   While $1 Million might not be enough to get you into TechCrunch, it will definitely allow you to hire a real developer and stop using WordPress.  In addition, using crowdfunding websites could actually be a form of marketing for startups, and allow them to reach other consumers. What remains to be seen though, is what sort of payout these equity holders will demand; I imagine they would be more like angel investors than VCs, however, you know what it can be like dealing with your current investors, now imagine a small army of them.”

These words echo President Obama’s comments when he signed the JOBS Act, that “Because of this bill, start-ups and small business will now have access to a big, new pool of potential investors – namely the American people. For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”

However, this new pool will certainly bring corporate housekeeping to the forefront as Yochiro Taku noted in his May, 2012 Business Law Today article, “Crowdfunding: Its Practical Effect May Be Unclear Until SEC Rulemaking is Complete,” noting, among the other realities of wide scale capital raising, that:

• The “bad actor” provisions mean no issuer can begin “crowdfunding” until the rules are promulgated.
• “Crowdfunding” will expand small companies’ financing options.
• Issuers will still need effective attorneys to ensure their corporate house is ready and able to work with new stockholders.
• The potential for officers and directors bearing liability for securities compliance before, during, and after an offering will require administrative resources typically not present in small business organizations.
• Ultimately, the SEC rules for “crowdfunding” offering materials may result in the need to draft prospectus-like documents.
• “The increase in number of stockholders as a result of crowdfunding may result in increased administrative burdens on issuers.”

Based on all the buzz about crowdfunding, it is easy for clients to see it as a panacea of relief from scraping by, greedy VCs, and tight fisted lenders, but it is clearly not going to a painless, inexpensive, free-wheeling capital raising event with no long term consequences or commitments no matter how liberally the rules are written.  Also, it bears repeating, “crowdfunding” is not legal yet.