Crowdfunding is an emerging way of funding; startups, new ideas, projects… by borrowing funding from a crowd (many people), e.g., family, friends, fans, connections….
Crowdfunding is the collective practice of people using the Internet to network and pool their money for a variety of purposes, including funding an early-stage company. Another aspect of crowdfunding is tied into the ‘Jumpstart Our Business Startups’ (JOBS) Act which allows for a wider pool of smaller investors with fewer regulatory restrictions. The Act was signed into law on April 5, 2012, and the Securities and Exchange Commission (SEC) has approximately 270 days from the enactment date to set forth specific rules and methods to ensure that funding actually take place. The JOBS Act adds a new equity crowdfunding exemption to the registration requirements of the Federal securities law. In other words, follow the rules and regulations that the SEC and other regulatory agencies hand down, then you will be able to use the Internet to raise money for your company. Crowdfunding allows; startups, ideas, projects… which do not fit the conventional venture investment pattern to attract funding through the participation of a crowd– you need a crowd (many people) to participate, e.g., family, friends, fans… According to the ‘Daily Crowdsource’; crowdfunding has gone from $32 million market to $123 million market in the past two years. In 2011, crowdfunded businesses and projects raised $102 million on rewards-based platforms, including $85.4 million raised by projects that reached their total funding goal… this signifies 266% increase in the total amount donated and 263% increase in the amount donated to projects that received their full funding. This explosion is attributed to the increase in the number of projects that are being posted online. More than 31,000 projects sought crowdfunded donations in 2011, up from just under 12,000 in 2010. The ‘Daily Crowdsource’ report says; not only are more projects being launched, but the number of projects achieving their full funding goal is also increasing, indicating the market is becoming more efficient at allocating resources…
In the article “Crowdfunding: What it Means for Investors” by Bill Clark writes: The crowdfunding feature of the JOBS Act will not only impact startups, it will also affect investors. That’s because the law allows almost anyone to invest in a startup, however, there is one catch: In the amended Senate bill, the SEC has 270 days to interpret and issue the rules for the public. That means potential investors may have to wait until 2013 before it’s legal to make an investment. In about 90 days the ‘Access to Capital for Jobs Creators Act’ should go into effect, allowing companies to tell the public that they are raising capital. In the past, this type of solicitation was illegal and could exempt the company from raising money privately. Now, startups will be able to solicit their deal, which could mean that more investors will hear about it. The caveat is that only accredited investors can participate in those deals where the company is soliciting. In other words, this will only apply to investors who fall into the following categories.
- Your net worth is more than $1 million, excluding your home.
- You have $200,000 in new income for the last two years and reasonable expectation to make $200,000 in the current year.
- You have $300,000 in household income for the last two years and reasonable expectation to make $300,000 in the current year.
If you don’t fall into these brackets, then you have several options: 1. Review campaigns on crowdfunding platforms, such as; Kickstarter, Indiegogo, Rockethub… Here, while you can’t make an actual investment in company, you will get something for your contribution. For example, if you invest in a video game you might get a copy of the game. 2. You can sign-up on a startup listing platform, e.g., Angellist, where you can check out startups for potential investment. Or, if you choose to wait until 2013, then as a new investor you will need to fill out a suitability questionnaire which will ensure that you understand the risks associated with investing…
A recent ‘Crowdfunding Industry’ report reveals incredible potential for equity-based crowdfunding, saying: ‘After collecting data from more than 170 crowdfunding platforms (CFPs) and other sources, the results revealed that CFPs raised almost $1.5 billion and successfully funded more than one million campaigns in 2011. As of April 2012, there were 452 crowdfunding platforms active worldwide; and there will be more than 530 projects by the end of 2012′. The report also found that the crowdfunding market is growing at the rate 63% CAGR (compounded annual growth rate) for total amount funds raised. The report identifies four categories of crowdfunding platforms:
- Equity-based (for financial return): Platforms grew 114% CAGR, primarily in Europe, and raised largest sums of funds per campaign; over 80% raised $25,000+.
- Donation-based (motivated by philanthropic or sponsorship incentive): Platforms raised the most funds at $676M, but the slowest-growing at 43% CAGR.
- Lending-based (P2P, P2B, and social): Platforms represent the second largest category raising $552M, and grew at 78% CAGR faster than donation-based.
- Reward-based (for non-monetary rewards): Platforms show very high growth at 524% CAGR, but from a low base of about $1.6M in 2009.
Surprisingly, it’s the reward-based model that currently accounts for the most amount of money in the crowdfunding industry (79%) at the moment (probably due in large part to Kickstarter’s model for success). Lending-based is currently the category with the smallest share, but that may change with the new crowdfunding bill. One determining factor in the growth of equity-based crowdfunding will be the ability for CFP’s to successfully satisfy SEC rules and become registered, then equity-based crowdfunding offerings are expected to rise exponentially. Another highlight of report concerned the rate at which fundraising takes place. The popular theory is; the first 25% of funds take longer to rise than the last 25%. However, according to ‘crowdsourcing.org’, it takes approximately 2.84 weeks to raise the first 25%, then 3.18 weeks to raise the last 25%, on average. The lending-based take less time than equity-based or donation-based campaigns. These figures could be important when considering crowdfunding strategies.
In the article “Before You Crowdfund, Read This” by Mark J. Mihanovic writes: The JOBS Act legislation is sweeping in nature, and it contains various provisions crafted to ease capital raising for privately held companies. The provision that has generated perhaps the most buzz is a new securities exemption that allows companies to raise up to $1,000,000 per year from large numbers of investors through funding portals. This allows companies using crowdfund equity financing to greatly expand their potential sources of capital. However, crowdfunding comes with some potential pitfalls. So if you are an entrepreneur forming a startup, you will want to map out your near-term and long-term financing strategies before you decide whether to go the more traditional route of friends-family, VC financing, or try crowdfunding. Here are a few points to keep in mind:
- The crowdfunding provisions of the JOBS Act legislation include various requirements and complexities that your early-stage company must adhere to, including (a) specified disclosure obligations, (b) rules regarding which funding portals and brokers you can use in crowdfunding financings and (c) per-investor caps on investment amounts, which could prove difficult to navigate. The SEC will announce its regulations within the next several months, and that could have a significant impact on the utility of the crowdfunding option.
- It could cost you significant time and expense to do the administrative work associated with record-keeping and potential contractual arrangements with large numbers of stockholders. Further, a greater number of stockholders could translate into a greater number of disgruntled stockholders, further translating to more potential stockholder lawsuits. This in turn could lead to, among other bad things, higher directors liability insurance costs.
- It might be difficult to obtain venture capital once you have taken a round of crowdfunding, so it’s likely crowdfunding will become an alternative route, rather than a stepping-stone to venture capital financing. In short, if you are considering near-term crowdfunding, be aware that the transaction might foreclose venture capital investment down the road.
In the article “Crowdfunding Mistakes that Can Kill a Campaign” by Scott Steinberg writes: The biggest misconception people have about crowdfunding sites is that once they post their project up, things will fall into their laps with little effort. That is not true folks. ‘All growth depends upon activity. There is no development physically or intellectually without effort, and effort means work’. Here are some fun facts that will help you reach success; 75% of crowdfunding projects use well crafted video to help gain more support, 65% posting users shoot video themselves, and 80% users share post on their Facebook, Twitter, personal blog and other media outlets that will help raise awareness. Projects with clever and enticing giveaways have 70% higher success rate, and if blogs or large publications pick’s up your post, the project will experience significant boost. There are many ways to success; it just depends on what steps you take, hard work, and a lot of marketing…
Business startup activity is at its lowest point on record– a point worth paying attention to since, historically, startups have created an average 3 million jobs annually, while existing firms lose 1 million jobs each year. As a ‘Kauffman Foundation’ report puts it: Startups aren’t everything when it comes to job growth. They’re the only thing. According to the ‘Silicon Valley Watcher’, the latest report on trends in U.S. venture investments shows a massive decline of 40% in seed investments in U.S. startups in the final quarter of 2011, and a much larger drop of 48% for the entire year. According to Dane Stangler; the U.S. badly needs to encourage a ‘producer’ economy– in which more people create their own companies and entrepreneurial opportunities– instead of the current ‘consumption economy’. Proponents of the crowdfunding say that it will increase startup activity, whereas, critics argue that it will create– or exacerbate– a kind of speculative attitude. Also, the concern that lowering the barriers for entrepreneurs… to raise money will also make it easier for fraud artists… to take advantage of individual investors. For many companies (in particular, those unable to get venture capital whether due to size, business sector, or geography), crowdfunding will make a great deal of sense… although, it’s highly unlikely that crowdfunding will change the game plan for companies that would otherwise be able to secure venture capital financing. Crowdfunding might just be the answer that will allow for a consistent flow of funds for startups… but, until SEC releases regulations it’s anyone’s guess on the potential impact. In the meantime, a prudent approach for startups, entrepreneurs… and investors, alike, is to sit back and wait until we get a bit more clarity.
The crowdfunding alternative is new, evolving and subject to the securities laws and related liability. As such, you will probably need advisors– accountants, lawyers… to help navigate the regulations, disclosures and ongoing compliance.