The people's marketplace
| Crowdfunding enables business startups to raise money via Internet donations. |
You say you'd love to land $100,000 or so to get your promising new business idea off the ground? Join the crowd.
Literally. For people aiming to fund a new project or enterprise, there may never have been a better time to tap friends, relatives and total strangers who may be willing to fork over a few bucks to help. This, you see, is the era of crowdfunding.
In a nutshell, crowdfunding is a way to get small amounts of money from a large number of people using the Internet. A cousin to crowdsourcing, which is used to gather ideas and expertise, crowdfunding pulls in cash for purposes that range from launching a business or developing a new invention to supporting a charitable cause. Because the mechanisms for reaching donors—via Internet websites and social media—are the same in every case, the potential uses seem endless.
Paul Dietzel is one among local entrepreneurs who have seen the power of the crowd. Early this year he launched a company called Anedot that enables nonprofits, political candidates and charitable groups to easily accept payments on their websites, Facebook and mobile phones.
“It's funny, because a lot of the transactions amount to, like, five dollars; but when a lot of people jump in, the dollars add up fast,” Dietzel says.
Anedot's simple setup and software for accepting payments make fundraising easy for organizations that aren't equipped to build their own systems, he says. His company makes money by charging a fee for each transaction.
Changes ahead
The National CrowdFunding Association (yes, there's an association) describes crowdfunding as “the people's marketplace.” And while the concept has existed for a number of years, it is poised for a transformation.
Last April, President Barack Obama signed into law the Jumpstart Our Business Startups, or JOBS Act, a portion of which aims to help small businesses raise up to $1 million by selling equity via the Internet, mainly to small-dollar investors. The law expedites such sales by exempting crowdfunding from burdensome provisions of the longstanding Securities Act.
Having a simple way to sell stocks enables an entrepreneur to bypass traditional financing sources—such as venture firms, “angel” investors and lenders—and directly pitch the masses for cash via a Web page, supported by marketing messages on Twitter, Facebook and the like.
David Rieveschl, a securities lawyer with the Baker Donelson firm, says the new law presents interesting financing possibilities, but selling stock over the Internet will not be an entrepreneurial slam-dunk.
“Crowdfunding under the JOBS Act means selling an equity stake in your company, which brings it under the purview of securities laws and all the scrutiny that goes along with that,” he says.
Current U.S. securities laws are rooted in the era following the Great Depression, when Congress was eager to instill stability and public confidence in stock trading processes. The lawmakers came up with a series of checks and balances aimed at preventing fraud, and they required companies selling stock to the public register the offerings with the Securities and Exchange Commission and make annual reports to shareholders. The penalties for misrepresentation are stiff.
While crowdfunding will be exempt from many existing regulations, the SEC must write new rules to ensure that only investors who meet minimum standards of income or net worth can purchase stock in this way. Rieveschl says entrepreneurs also should understand that buyers of the stock become legal shareholders.
“How many little startups have the ability to deal with a few hundred shareholders asking them questions and expecting to see annual reports on the business?” he asks.
Market signals
Based on what he knows about crowdfunding, Rieveschl favors more traditional ways of amassing equity capital. “If you can raise a million dollars from a savvy angel or seed-stage investor who puts in expertise and guidance along with money, I'd go with that every day of the week,” he says.
Still, crowdfunding in its current form is not without value for entrepreneurs, he says.
Many business startups around the country are tapping into big crowdfunding platforms such as Kickstarter and Indiegogo to solicit presales of their products. Typically, a startup owner offers a discounted price on the product to attract buyers; the owner takes in cash, then uses the money to fund initial development or manufacturing costs, and delivers the products to the buyers at a future date.
“I love the idea of bringing in money a business can use to develop the product,” Rieveschl says.
As entrepreneur Seth Froom recently learned, the benefits of the process go beyond the bucks.
The co-founder of Yellow Jacket, Froom is an inventor who aims to market an innovative smartphone case that's equipped with a stun gun for personal defense. He recently signed up with Indiegogo to presell the product.
Froom and his business partner Sean Simone created a snappy Web page for the offering and put the Yellow Jacket cases on sale at $100 each, with plans to sell them for $125 when they arrive in retail stores this fall. Yellow Jacket raised $100,000 during the month-long offering.
The money will cover the initial round of manufacturing, enabling the company to deliver its product to early buyers and to retailers that have committed to carry them. But Froom says the crowdfunding experiment also had a crucial spinoff benefit.
“It showed that there is a market for our product—people saw the value in it,” he says.
Testing the market in this way is simpler and less risky than going through a stock offering, he says. “Crowdfunding was a way to launch without losing equity.”
Anedot's Dietzel offers a similar assessment. He says he'll keep Anedot focused on fundraising for charitable causes and political campaigns for the moment, but that crowdfunding can provide a business with valuable market indicators.
“If you offer a product and buyers don't respond, you'll have a lot less to lose than if you had taken on a large investment and then realized you should have gone in a different direction,” he says.
The SEC is at work on rules for implementing the crowdfunding provision of the JOBS Act. Presumably, the final rules will help reassure both businesses and investors of a solid and secure process for selling equity over the Internet. The first tests will come when the law finally takes effect, probably during 2013, Rieveschl says.
The JOBS Act amends the Securities Act of 1933 by adding a registration exemption for crowdfunding transactions as long as certain requirements are met. Securities issued under the exemption will be subject to a one-year holding period and will not have to be registered with any state securities commission.
Issuer requirements
An issuers must:
• be a U.S. company
• not be a reporting company or investment company
• seek to sell no more than $1 million worth of securities via crowdfunding in a 12-month period
Investor requirements
• Investors with an annual income or net worth below $100,000 may only invest the greater of $2,000 or 5% of annual income or net worth.
• Investors with an annual income or net worth greater than $100,000 may only invest 10 percent of annual income or net worth, with a $100,000 maximum.
Information and disclosure
Issuers will be required to file certain information with the SEC and provide the same information to potential investors and intermediaries, including:
• an initial filing containing basic details about the issuer and its finances
• annual financial statements and a report on results of operations
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