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Crowdfunding: Financing of the Future?
Crowdfunding: Financing of the Future?
By Sallie Hyman
Have a great idea or product that you think will make you money? Or do you already have a small business that is ready to grow? Where will you get the money you need to start up or grow?
An online member survey conducted by the NASE regarding small-business funding found that 57 percent of small-business owners used personal savings to initially fund their business, while 12 percent utilized credit cards for start up. Seventy-five percent of members felt that funding opportunities were inadequate.
According to a recent survey by Experian, most small and medium enterprises rely on traditional bank loans or personal sources of cash for funding. Experian surveyed 300 small and medium enterprises and found that awareness of different types of business finance is very low among this group.
Many alternate forms of financing are available, but few know what they are. Crowdfunding was the least well-known funding form among respondents, with 69 percent never having heard of it.
And that is a shame. $1.5 billion dollars in crowdfunding transactions took place in 2011, $3 billion are anticipated in 2012, and estimates for the future go as high as $500 billion annually.
So what is crowdfunding?
Crowdfunding or crowd-sourced backing is a way of financing a project or business through small donations from many (hundreds to thousands) of investors. Crowdfunding first became popular with independent musicians and movie producers who needed cash to produce a record or movie when they could not get a big studio to pick them up. They used social media such as Facebook to reach out to their friends and fans to ask them for a small amount of money to fund the project. Traditionally, investors receive some token in exchange for their donation, such as a free copy of the music CD or the movie DVD.
NASE Member Sydni Craig-Hart is exploring the world of crowdfunding for her latest business venture. Although she had heard of ways that social media could help fund projects, she was able to see what a significant impact it could make when a networking colleague passed away suddenly. His widow set up a social media site for donations to help keep their small business running. Craig-Hart saw how the community reached out to this woman to help her keep her dream alive.
“If people believe in you, they are happy to back you,” says Craig-Hart.
She also believes that lack of funds should not keep you from starting a business. She wants to model her crowdfunding project so that other women who are interested, yet hesitant, to start a business, can see how it can be accomplished. Craig-Hart is in the development phase of her campaign and is looking to launch her projectin January 2013, possibly on the crowdfunding site Indiegogo.
The Birth of Crowdfunding
The idea started back in the late 1990s with the British rock group Marillion, which raised $60,000 from its fans to fund an American tour. In 2008, in the United States, a group led by Mike Migliozzi, a social media marketer, saw the power in using social media to bring people together for business, as well as social matters.
Migliozzi used it to bring people together to buy Pabst Blue Ribbon Beer, which had recently been put up for sale. His “crowd” raised $282 million toward the purchase of the $300 million company. Unfortunately, Securities and Exchange Commission (SEC) regulations prohibited this type of funding at the time.
However, the future of business funding was about to change.
Enter Kickstarter. Kickstarter is a funding platform for creative projects. Anyone with an idea can go to the Kickstarter site, set up a campaign for their project, and solicit donors. Since its launch in 2009, more than $350 million has been pledged by more than 2.5 million people, funding more than 30,000 creative projects.
Crowdfunding Principles
Although Kickstarter was one of the first funding platforms, there are now hundreds of different sites that fund projects of every kind. What most have in common, though, is an all-or-nothing funding philosophy.
According to Kickstarter, this is a core part of its funding and the company has found a number of advantages to this policy. “It’s less risk for everyone,” according to the Kickstarter website. “Investors know their money won’t go to waste and that you will have enough money to complete the project. If you need $5,000, it’s tough having $1,000 and a bunch of people expecting you to complete a $5,000 project. It motivates. If people want to see a project come to life, they’re going to spread the word. It works.”
Of the Kickstarter projects that have reached 20 percent of their funding goals, 82 percent were successfully funded. Of the projects that have reached 60 percent of their funding goals, 98 percent were successfully funded. Projects either make their goal or find little support. There’s little in between. To date, 44 percent of all Kickstarter projects have reached their funding goals.
Some funding platforms, such as Indiegogo, allow for non-fully funded projects to take whatever monies they have raised, but will charge a fee for doing so. And that brings up the question of what do these funding platforms get out of setting up websites to find donors? Most charge a percentage fee, usually between 5 to 10 percent per project.
The JOBS Act
The original idea behind crowdfunding was to use social media contacts and funding platforms to raise money in exchange for non-equity capital for creative projects and charity causes. Such funding does not involve the sale of securities (stocks, bonds, or other financial instruments designed to give someone claim over future assets of a company).
This goes back to why the Pabst Blue Ribbon deal failed.
At the time of that attempted buyout, U.S. law prohibited regular investors from owning equity. Since all of the investors committed to the Pabst Blue Ribbon sale were regular investors, and not accredited investors, the transaction was illegal.
Accredited investors are investors who make more than $200,000 a year as an individual, $300,000 per year as a couple, or have $1 million or more in net assets excluding their home. The whole point of crowdfunding was to allow smaller investors to get into the game.
This set into motion the “Startup Exemption Framework,” developed by Jason Best and Sherwood Neiss, which became part of the JOBS Act passed by Congress in April 2012. The passage of this act now allows small businesses to use crowdfunding to seek investors (accredited or not). A company can raise up to $1 million in equity investments this way. To protect investors, those with a net worth of less than $100,000 may now invest 5 percent of their yearly income or $2,000, whichever is higher. Wealthier people can invest up to 10 percent of their income.
Neiss and Best have also helped organize two groups to help Congress with the regulations as well as educate those seeking investments and investors themselves. The groups are the Crowdfunding Professional Association and the Crowdfund Intermediary Regulatory Advocates.
The Crowdfunding Professional Association (CfPA) is dedicated to facilitating a vibrant, credible and growing crowdfunding community. The association has a very informative website, hosts webinars on crowdfunding basics, and organizes a multi-day bootcamp to teach entrepreneurs about crowdfunding.
Kickstarter and Indiegogo-type funding comes with relatively few strings attached. The money you get can be used in any way which facilitates the completion of the project. Investors will expect that the project is completed, probably want their free copy or bragging rights in a credit, but have no say in how you run your company or spend their money.
The JOBS Act now adds a new twist to crowdfunding. If you choose to raise money from investors by selling equity in your business, you have now sold away a part of your company and need to make very clear what rights investors have in decision making for the company.
Remember that most of these investors will be non-professional, unsophisticated investors who may not know the first thing about running a business. But if you let them invest, you may have given them the right to tell you how to run things. And the more investors you have, the more opinions you need to deal with. You will need to very carefully mange the technical participation of investors through voting rights, reporting rights, and whatever other terms you set.
Crowdfunding may just be the financing wave of the future.
It can be a great way to secure funds for a new idea or funding for growth in a successful small business ready to grow.
Whatever the case, make sure that you know what type of funding platform suits your needs the best, that you know about and control any sale of equity in your company, and that you carefully read the SEC regulations as they apply to your situation.
Sally Hyman writes on small business issues and owns and operates her own small business in Leesburg, Va.
Popular Crowdfunding Websites
- Kickstarter: The largest crowdfunding site. Good for general interest projects.
- Indiegogo: Preferred site for filmmakers, musicians and artists. Allows partial funding.
- Crowdrise: Provides a public source for charity fundraising
- Grow VC: An international platform that aims to connect profit-minded investors with entrepreneurs.
- Peerbackers: Caters to entrepreneurs and start-ups.
- Microryza: Allows anyone interested to fund scientific research.
- Upstart: Targets recent grads who need seed money.
- Fundable.com: Seeks to help start-ups exchange funds for equity
- RocketHub: Offers exclusive real-world opportunities such as gallery showings, music showcases.
- Bolstr.com: Seeks to help start-ups exchange funds for equity.
- . Do your homework: Know your project thoroughly before you start. Know how much money you need and how you will use it.
- . Research to find the funding platform that best suits your needs. Kickstarter is great for most projects, but it you have a health care idea, you need to look elsewhere. Ready to trade some equity for funding? Try Bolstr.com or Fundable.com.
- . Present the best project you can. Spend time to put together your funding campaign. You are presenting this to real investors and they want to see a real plan. Make sure you follow the guidelines on the funding platform’s website.
- . If you are trading equity for funding, know exactly what rights your investors will have in the company and state them very clearly in your campaign. Seek legal advice to be sure you have presented them properly and legally.
- . Get your friends and family involved. Even though you are looking for a wider circle of investors, recruit your social network to get the word out about your project.
- How much funding do you really need?
- What kind of funding do you need?
- What are the best sources?
- Where can you find the least expensive money?
Crowdfunding: Financing of the Future?