In recent years, many entrepreneurs have turned to crowdfunding in their efforts to raise capital. Platforms like Kickstarter and Indiegogo largely popularized this method of financing, but the industry is only in its infancy, with options in this space growing day by day. With the implementation of federal crowdfunding rules in May 2016, startups and small businesses in the U.S. now have a legal framework for equity-based crowdfunding, allowing for private offerings of securities to a much wider pool of investors. There are, however, significant restrictions in place making this option less attractive for some business owners.
So how do you decide if crowdfunding is right for your business? Here are the basics:
The word “crowdfunding” is often synonymous with the crowdfunding site Kickstarter, a reward-based platform. With this type of crowdfunding, individuals pledge money to your business idea in exchange for some type of benefit. A significant upside to reward-based crowdfunding is that you are not giving up ownership of your business in exchange for capital: reward-based crowdfunding is more analogous to selling a product than taking on investors.
Some start-ups have found enormous success using this method of crowdfunding, with projects like the Pebble smartwatch raising $2.6 million on Kickstarter in only three days. However, this method tends to work best for creative projects or consumer goods that grab attention and are easy to understand. Software or tech companies looking to raise significant amounts of capital are often better served using other types of fundraising.
Equity-based crowdfunding platforms are akin to online venture capitalists, connecting companies seeking investment to a wide range of small investors. Even reward-based platforms are branching into this space, like Indiegogo, which recently partnered with equity platform Microventures to form a new securities crowdfunding portal.
True equity crowdfunding was only made possible through the Jumpstart Our Business Startup (“JOBS”) Act, passed in April 2012, and its implementing regulations, adopted by the Securities and Exchange Commission (“SEC”) in October 2015. These rules now allow companies to raise up to $1 million in a crowdfunded offering during any 12-month period, although individual investments are capped at certain amounts depending upon the investor’s income and net worth.
Companies who choose this route should consider the significant requirements placed upon them, including sharing an annual report, with financial statements, on the company’s website and filing this report with the SEC. For early stage businesses, preparing such a report may be too burdensome, and the risks of sharing sensitive information with the public too great.
Under the JOBS Act rules, all equity crowdfunding must be conducted through registered intermediaries, meaning the platform itself must be registered with the SEC. This registered intermediary is also required to have a financial interest in the company raising funds. As a result, often 10-15 percent or more of each fundraising round will be given over as an upfront fee to the platform. For smaller businesses, this cost is simply impractical.
When financing your business, remember you have multiple options. Consulting with the right attorney may help you figure out which decision is best for your company.