Ever had a great idea but nowhere to turn for capital to get it off the ground? Entrepreneurs and startups all across the country frequently face this dilemma. Some turn to friends and family (or even to more sophisticated “angel investors” if the idea has substantial promise) to provide sorely needed initial capital. Traditional sources of debt financing such as home equity loans, commercial financing or even microloans can also help, but in some cases the individual may not meet the criteria required or the amount of capital needed is too large or too small, as the case may be. No matter where the business owner turns, difficulties in getting the critically needed funding have always been a fact of life.
Help may now be more readily available through “crowdfunding” (also called “crowdsourcing”), which continues to grow in popularity. In crowdfunding, a large number of individuals pool funds (usually through social media or internet “funding portals”) for purposes of providing capital to specific products or ideas. There are two common types of crowdfunding. The first is a “donation” model, which provides the funder with designated rewards (ranging from discounts to actual products). The other type is an “investment” crowdfunding model that provides actual equity ownership in the recipient company.
Although the idea for crowdfunding has been around for years, the impetus for making crowdfunding a reality came with the signing of the Jumpstart Our Business Startups Act (JOBS) by President Obama in April of 2012. The JOBS Act provided a framework for stimulating funding of smaller and startup businesses and relaxing certain regulatory hurdles faced by these companies. As part of this process, the JOBS Act directed the U.S. Securities and Exchange Commission (the “SEC”) to develop rules for implementing crowdfunding. In late March of this year, the SEC issued its final rules for a two-tiered crowdfunding structure which will enable companies to sell up to $50 million of securities ($20 million under the lower tier) in a 12-month period, subject to certain eligibility, disclosure and filing requirements. As a result, crowdfunding is likely to increase in popularity, because it will allow the everyday “non-accredited” investor an opportunity (subject to SEC limits) to invest in new projects.
Crowdfunding sites, such as Kickstarter, Indiegogo, Rockethub and Crowdfunder.com not only provide members of the general public the opportunity to fund business proposals (generally called “projects”) that appeal to their subjective tastes or sense of activism, but also provide venues for entrepreneurs to submit their business start-up ideas for public backing. The result of this is that equity funding sources are no longer limited to either personal relationships or a local geographic area. A unique product or business model can now appeal to potential investors across the country, removing barriers and boundaries to accessing the capital needed to get to market.
Crowdfunding is not for everyone. The SEC’s new rules place substantial limitations on issuers and investors alike, as well as filing and disclosure requirements similar to those required of other business entities selling securities. Because the SEC rules (and crowdfunding in general) are so new, expect a substantial “trial and error” period to iron out the kinks in the new funding regime.
If crowdfunding looks like it might be something that fits your needs, you still have a lot of work ahead to get your business idea (and your business) into position to be ready to take advantage of crowdfunding. There are some important steps and considerations for anyone thinking about crowdfunding:
- Determine if crowdfunding is right for your business model. Is the business idea, product or solution unique enough to attract crowdfunding? Are the capital needs of your business appropriate for crowdfunding?
- Make sure your business is set up properly. Do you have an operating business entity or is this still a dream or a “napkin drawing”? Are you maintaining corporate formalities and avoiding problems? Additionally, you will need to either write a solid business plan or review and revise your current plan if you already have one.
- Consult business, accounting and legal professionals. Depending on the size of the offering, you will need to draft offering and disclosure documents and make the appropriate filings. The securities rules, even for crowdfunding, can be complex. For instance, you will need to understand the mechanisms and rules for crowdfunding and be able to evaluate for yourself the pros and cons of this type of funding. Your financial records may need closer scrutiny by a CPA, depending on the amount of funding you are seeking.
- Make sure your intellectual property is protected. Nothing will kill a great business idea like disclosing the underlying, unprotected intellectual property to the public or inviting unwanted competition by putting your model out for public scrutiny. Got a new design? Look to patent it. Got a catchy name for your product or business? Seek trademark protection. Investors will also want to know that an idea which they are crowdfunding has a strong IP position.
Like any business venture, there are always risks, both for the investor and the entrepreneur. Due to the presence of many smaller investors, the individual risk to a single larger investor may be mitigated in the early (and riskiest) stage of the business. Even with the inherent risks, crowdfunding promises to provide a source of investment capital that was seemingly unimaginable only a few years ago. It also promises to provide inventive and entrepreneurial individuals with a means to access the broader market and make a public appeal for the success of the “next big idea.”