On Friday, October 30th, after a three-and-a-half year wait, the SEC approved Title III of the JOBS Act. Beginning May 16, 2016, investors nationwide will be able to participate in equity crowdfunding, a marketplace formerly reserved for investors of high financial standing, through select crowdfunding platforms. Investors making less than $100K per year may invest the greater of $2,000 or 5% annual income. Investors making more than $100K per year may invest up to 10% of their annual income. Startups and small businesses can raise up to $1M in a twelve-month period.
With the approval of Title III, and the ensuing growth of participating investors, online crowdfunding will likely far exceed earlier estimates of $34 billion a year (on track to reach a $1 trillion by 2025). Crowdfunding has become a globally successful method for financing ventures in the Information Age. Projects both massive and modest, innovative and traditional, charitable and commercial, can now be funded with unprecedented ease. There are more opportunities than ever for donors to donate and investors to invest. But for the uninitiated: What exactly is crowdfunding? How does it work? What is all the fuss about?
post provides project initiators and backers with an overview of crowdfunding:
its many variations, its benefits and risks, and its future.
General Types of Crowdfunding
Crowdfunding is a method to raise funds for a project or business venture using many donors or investors via an online platform. A company, group, or individual fundraising campaign advertises details of a project or venture on the platform, usually with a specified fundraising goal and deadline. Within the designated amount of time, people can donate or pledge and invest their preferred amount (meeting the site’s and the SEC’s requirements) toward a project.
The most famous crowdfunding platforms include Kickstarter and Indiegogo, which have conducted highly publicized campaigns to fund the creation of albums, films, and novelty products such as the “Coolest Cooler.” Donors to crowdfunding campaigns often receive perks or a reward, such as a gift certificate, for their contribution. This is known as “rewards-based crowdfunding.” Certain platforms focus on philanthropy and social engagement, such as Zidisha, which employs a direct person-to-person lending model to support low-income small business owners in developing countries. A savvy promoter could even use crowdfunding to fund their move to New York City or London, or to pay their college tuition. The success of such campaigns depends upon reaching the right people with the right message.
platforms, such as Crowdfunder, specialize in raising investment capital. Real
estate crowdfunding platforms operate similarly, raising capital for
residential and commercial real estate companies who are otherwise limited in
their financing options. With crowd investing, the rewards as well as the risks
involve larger sums of money.
The two primary methods of raising capital through crowd investing mirror two of the primary methods used to fund startups: either through Equity or Debt financing.
Defining Equity and Debt Crowdfunding
In equity crowdfunding, a backer or investor receives shares of a company in exchange for money pledged. The platform can set investor caps, minimum pledge amounts, etc. Prior to approving Title III of the JOBS Act, the SEC had limited participation in equity crowdfunding to accredited investors. Come May 16th, the rest of the population will be able to participate in equity investments on platforms that have registered under Title III.
In debt crowdfunding, a backer or investor loans money to a person, company, or business interest with the understanding that their loan will be paid back with interest, usually over a period of several months. Debt crowdfunding is regulated by the SEC the same way as equity crowdfunding, and as a result, the two are sometimes lumped together as “equity crowdfunding.”
Most real estate crowdfunding platforms offer debt and equity opportunities, so investors are usually free to choose how their investments are conducted.
For Companies and Project Initiators
Crowdfunding campaigns provide companies and project initiators with a number of benefits beyond strictly funding projects.
Boosting Your Profile: A compelling project can boost a company or entrepreneur’s presence and reputation in a competitive marketplace.
Exposing a Market: A successful crowdfunding campaign can reveal an untapped market and audience for a specific project or venture. Even an unsuccessful campaign can yield valuable market knowledge.
Engaging an Audience: Crowdfunding platforms provide a forum for project initiators to engage with their audiences and form enduring business relationships.
Feedback: Project initiators can receive instant and reliable feedback by offering backers pre-release access or the opportunity to beta-test content.
For Investors and Project Backers
In addition to financial benefits or other rewards for funding projects and ventures, investors and project backers can also achieve the following through crowdfunding:
Build Relationships: Crowdfunding initiatives offer backers, donors and investors the opportunity to build relationships with project creators as well as other funders. Backers can also engage in the production process and share feedback.
Acquire a Personal Stake in Projects: Companies and individuals choose to crowdfund projects for substantial reasons. Products, services, and ventures that are possibly revolutionary but still unestablished can only break into a market with the reliable support of project backers. By financially contributing to a project, a backer can feel personally involved in the project’s execution and success in a way that only crowdfunding permits.
Fund a Humanitarian Service: Depending on the crowdfunding initiative, a backer’s contribution may help protect/heal the environment, strengthen communities, or provide vital resources to people in need around the world.
Crowdfunding Risks and Barriers
For Companies and Project Initiators
Crowdfunding also carries some
risks, in addition to default, market or other financial predicaments, that
companies and individuals should be aware of before using a platform.
Reputation: Failing to meet campaign goals or to generate interest may result in a publicly-recognized failure for a company or entrepreneur. Failing to deliver on a project despite meeting financial goals and gathering public support can also damage the the reputation of a project initiator. In such a case, donors or investors once loyal to the company or creator may reject their future campaigns.
Donor exhaustion: If a company or individual approaches the same network of supporters multiple times, that network may eventually cease to support their endeavors. Project initiators should see the crowd as partners in the project, with their own own valid concerns, rather than a prop or a means to an end.
For Investors and Project Backers
Project Failure: Project backers should always be aware that any project could fail for a number of reasons, including new regulations, an economic downturn, poor handling of funds, etc. Backers who donate expecting a reward or invest expecting high returns should especially be conscious of circumstantial risks. Markets and investments are volatile. Do not invest or contribute any amount that you are unprepared to lose.
Fraud: The biggest non-market or circumstantial risk posed to backers is fraud. The FTC recently took legal action against a project creator who raised money through Kickstarter to produce a board game, but ended up spending most of the funds “on unrelated personal expenses such as rent, moving himself to Oregon, personal equipment, and licenses for a different project.” (FTC) While uncommon, such activity threatens the financial security of individuals and the viability of crowdfunding as an industry. While the FTC and SEC are actively regulating and passing new laws to protect consumers involved in alternative finance, fraudulent activity persists as a threat. Investors should do their own diligence on projects in addition to the diligence a platform may perform. Be vigilant and see that your money goes to places and people who use it with integrity.
Crowdfunding Today and In the Future
Crowdfunding is presently a multi-billion dollar industry asserting itself deeper into the public consciousness. Prior to the SEC approving Title III of the JOBS Act, various states passed their own crowdfunding laws to regulate the industry, reflecting its exponential growth and influence in the past few years. Although similar methodologies existed before the internet, crowdfunding as we recognize it today is a uniquely 21st century business model. It represents a democratic mode of financing, operating more independently of banks and hard money lenders than traditional modes of financing. Innovators and regular people can work together in a mutually beneficial network, changing lives around the world and helping entrepreneurs realize their boldest visions. Much like YouTube at its inception, crowdfunding gives a stronger voice to a greater number of people.
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