I don’t particularly like crowds. when it comes to crowdfunding startups I love them because crowds are wise, crowds are generous, and crowds are wealthy. Crowdfunding means exactly as it sounds, funding from a crowd — sourcing capital from people outside the immediate network of friends and family of an entrepreneur, producer, or non-profit organizer. But this isn’t your grandmother’s crowdfunding era, when the practice was limited to collection plates passed during religious services, or even your mother’s crowdfunding days of televised fundraisers or neighborhood bake-offs for a cause. Today crowdfunding startups, small businesses, and charitable campaigns happen almost entirely online, on portals like Kickstarter.com, Indiegogo.com, SoMoLend.com, Funrise.com, Fundable.com, Angelist.com, Crowdfunder.com and many others. The potential impact on capital markets and innovation is evident.
TYPES OF CROWDFUNDING FOR STARTUPS
Crowdfunding campaigns fall into one of four categories, although hybrids are also possible.
- Donation Based Crowdfunding is where contributions go toward a charitable cause that is usually non-profit, although the organization need not be a registered non-profit under 501(c)(3) rules to solicit donations online.
- Reward Based Crowdfunding is the currently the most widely used category, where investors (or “backers”) receive a tangible item or service in return for their funds. This includes offers for a “first edition” of a product, free access to premium services of a soon to be launched website, a role or credit in a film, or other interesting perks. Reward based crowdfunding provides many creative opportunities for companies to induce backers to give. However, the rewards offered, which can be interpreted as legal as contracts between the campaign and the backers, are riddled with potential legal issues, such as intellectual property infringement claims, tax implications on the funds raised, truth in advertising considerations, and even potential labor code violations when, for example, a role in a film is offered in exchange for a contribution.
- Lending Based Crowdfunding on platforms such as Somolend.com and Kiva.org provide an opportunity for investors to be repaid for their investment over time, and some platforms boast a 98% return rate, unheard of in US commercial banking sectors.
- Equity Based Crowdfunding, the emerging category which is NOT yet legal* provides “investors” with an equity share in the venture. This category of crowdfunding, potentially akin to a mini Wall Street and stock exchange for tech startups and small business will offer an unprecedented legal and technological vehicle to capitalize a startup.
EQUITY BASED CROWDFUNDING
The Jumpstart Our Business Startups Act (JOBS Act) set in motion legalization of general solicitation of equity fundraising from the public without filing traditional IPO documents, under limited circumstances. Signed into law in April 2012, the JOBS Act charges the Securities and Exchange Commission (SEC) to provide rules governing equity crowdfunding and how investors, entrepreneurs, and portals interact. Rules which due to considerable debate probably won’t be out until 2014. The SEC rules on equity crowdfunding will likely be more strict than people want, but it will be easier than it is today to raise capital in this way. Some of the general provisions of equity crowdfunding under the JOBS Act include:
- A cap on how much investors can invest in crowdfundings per year, currently 10% of annual income or net worth of investors who’s incomes are $100,000 or more, or the greater of $2,000 or 5% of annual income or net worth for investors with incomes of less than $100,000.
- The requirement to work through a broker or portal (website) which must be registered with the SEC.
- A cap on the amount raised in equity crowdfunding to $1,000,000 per year. Donation and reward based crowdfunding currently have no caps.
- Tiered disclosure requirements based on the amount raised.
CROWDFUNDING STARTUPS AND RAISING CAPITAL
Crowdfunding startups is poised to disrupt how capital flows into small businesses. Yes there will be some legal hoops to jump through, primarily because of concerns for fraud. But with fewer than 1% of startups currently funded by venture capital and angel investments, coupled with continuing squeeze on traditional financial markets, crowdfunding will further democratization of access to capital, just as the internet democratized access to information, and its impact on innovation may be second only to the world wide web itself.
*Some limited forms of equity crowdfunding are available to accredited investors today, such as Angelist.com.
Author: David N. Sharifi, Esq. is a Los Angeles based intellectual property attorney and technology startup consultant with focuses in entertainment law, emerging technologies, trademark protection, and “the internet of things”. David was recognized as one of the Top 30 Most Influential Attorneys in Digital Media and E-Commerce Law by the Los Angeles Business Journal in 2014. Office: Ph: 310-751-0181; firstname.lastname@example.org.
Disclaimer: The content above is a discussion of legal issues and general information; it does not constitute legal advice and should not be used as such without seeking professional legal counsel. Reading the content above does not create an attorney-client relationship. All trademarks are the property of L.A. Tech & Media Law Firm or their respective owners. Copyright 2013. All rights reserved.
Crowd image courtesy of James Cridland (Flickr). Money tunnel image courtesy of Ramberg Media Images (Flickr).