Following is an introduction and overview of the benefits and possible disadvantages to using crowdfunding to finance your enterprise.
The recent economic crisis has made the capital markets much stingier. This has given rise to a new tactic to raise capital for creative, philanthropic and entrepreneurial ventures: crowdfunding. Federal crowdfunding legislation signed into law in April 2012 and expected to be implemented in 2013 should mainstream this financing method in the United States.
Crowdfunding is a method of accumulating capital with relatively small-sized investments from a large pool of individuals. A website usually serves as the intermediary between investors and projects. As an alternative source of financing, crowdfunding is rapidly growing in prominence.
This website offers an overview of crowdfunding with a focus on equity financing for small businesses. Keep in mind that, despite its promise, there are both advantages and drawbacks to crowdfunding for start-ups and emerging businesses.
AN INTRODUCTION TO CROWDFUNDING
Entrepreneurs can use crowdfunding to pitch an idea and solicit financing from anyone with internet access. At its most basic level, an entrepreneur simply uploads to a crowdfunding website a description of their idea or product, their business plan and the amount of capital they need. Sponsors also need to explain what funders will receive, either as a gift, repayment or equity stake, in the venture.
Prospective funders can visit crowdfunding websites to peruse listings. Depending on their motivation, from philanthropic to entrepreneurial, they choose projects to support. The amount of their support can range from a few dollars to the total solicited for the venture. Crowdfunding websites are designed to facilitate these transactions by holding funds in escrow then transferring them to the entrepreneur or returning them to the contributor if the project fails to go forward.
Crowdfunding first started to gain attention around 2005 as a means of utilizing the social networking potential of the internet to fund small creative/philanthropic projects such as films, books, music recordings, and charities. Since then, the use of crowdfunding to fund for-profit enterprises has taken off outside of the United States. Though the typical crowdfunded project remains small to modest in size, cumulatively crowdfunding has connected millions of investors with entrepreneurs to raised billions of dollars for small businesses.
There are three basic crowdfunding models based on incentives offers to investors.
The charitable model seeks donations from contributors based on their charitable or philianthropic interests. Contributors receive no monetary reward, though small tokens of appreciation may be conveyed just as in traditional charitable ventures. Also, gifts may be tax deductible.
The reward model offer contributors some kind of tangible benefit in return for their contribution. Rewards may vary depending on the size of the contribution. Contributions may in fact be pre-purchases of products or creative works or public credit on a film or music album.
The investment model allows for donations to be categorized as a loan or equity stake in a venture. It is this model that the JOBS Act allows.
With the investment model, investors expect repayment of principal with interest or and ownership stake in the venture. Investment crowdfunding has the potential to reward investors with a financial return and thus involves the purchase and sale of securities. Consequently it falls within the enforcement jurisdiction of the Securities and Exchange Commission (SEC).
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