What is Crowdfunding?
Crowdfunding is essentially a tool that entrepreneurs can use to attract investors via social media or shared interests in order to contribute to a funding goal set by the entrepreneur.
Below, I have posted a video of Dr. Peter Diamandis, who is the founder of the XPRIZE Foundation, who has personally used crowdfunding to raise over $2 million dollars for some of his businesses. He talks about crowdfunding and how much it has grown since 2012.
The Crowdfunding Industry Report by Massolution put out data showing the overall crowdfunding industry raised $2.7 billion in 2012, across more than one million individual campaigns globally. In 2015, the total global crowdfunding industry estimated fundraising volume was $34.44 billion, which was broken down as the following:
- Reward and Donation Crowdfunding: $5.5B
- Peer to Peer Lending: (Debt Crowdfunding) $25B
- Equity Crowdfunding: $2.5B
What Different Types of Crowdfunding Are There?
Many times you will hear the word crowdfunding used to describe many different types of funding and it can be a little confusing. Essentially, there are four “types” of crowdfunding.
- Rewards-Based Crowdfunding
- Donation-Based Crowdfunding
- Debt Crowdfunding
- Equity Crowdfunding
Below we look at each one in a little more detail.
1. Rewards-Based Crowdfunding
Typically, reward-based crowdfunding is where you “pre-sell” a product or service. For example, the Coolest Cooler, a by project by Ryan Grepper, an entrepreneur, raised $13 million USD, to manufacture a cooler with features, such as, a built in blender, stereo, bungee cords, the ability to recharge your phone, etc. Before he manufactured any of these coolers, he set-up a campaign for the cooler with a video. In exchange, anyone who gave money to his business for any amount above $5 received a “reward” or in this case, a party cup, in exchange.
The people contributing to the Coolest Cooler campaign cannot be considered investors because they did not receive any equity or shares of Coolest, Inc. in exchange for their money. Generally, in these types of crowdfunding campaigns, rewards tend to be some sort of trinket for your donation, such as, the party cup from Coolest, Inc. Examples of portals that specialize in rewards based campaigns include Kickstarter and Indiegogo.
2. Donation-Based Crowdfunding
Donation-based crowdfunding is being used by major charities and by individuals who are asking for donations for their cause. Generally, donors can choose how much to contribute and are not given anything in return for their contribution, except the warm fuzzy feeling of giving. There are many worthy causes online and online platforms allow each person to connect with the cause that they are passionate about. For example, children filmed themselves harassing a bus driver and posted it on Youtube.
The video backfired and someone that saw the video decided to create a campaign to send the bus driver on a vacation. The goal for the campaign was to raise $5,000.00 and within a week it had raised $703,168.00. No-one that contributed received anything besides a possible tax-deduction. They just wanted to help. Donation-based crowdfunding is typically used to raise money for a non-profit or a cause, like drilling a water well, building a school for children or for a personal campaign like an individual’s treatment or medical bills.
GoFundMe and Crowdrise are two popular donation-based crowdfunding platforms. Additionally, you can use Indiegogo and even Kickstarter for donation-based crowdfunding but you cannot receive advanced funds in exchange for a promise to donate funds raised to a charity or cause.
3. Debt crowdfunding
Debt crowdfunding or, peer-to-peer lending, is essentially an online business loan, where an interest rate is charged. The entrepreneurs will pay back the bank or lending institution with the principle amount of the loan plus interest. Sometimes the lenders can be called investors but they might not actually be investors, just lenders.
It is exactly like a loan from the bank or lending institution but instead of borrowing one amount from one institution the entrepreneur might borrow smaller amounts of money from multiple lenders. Debt crowdfunding opens up the market for microloans.
4. Equity Crowdfunding
Generally, equity crowdfunding refers to the act of an entrepreneur offering shares or equity in their company to one or multiple investors in exchange for capital, i.e. money. This kind of crowdfunding is most often used by early-stage companies to raise “seed funding.”
In order to fully address the impacts of recent developments, entrepreneurs need to understand all of the rules related to crowdfunding that changed in recent years due to President Obama’s Jumpstart Our Business Startups (JOBS) Act.
Every time a startup raises money in exchange for shares of its company, the transaction must be registered with the U.S. Securities and Exchange Commission (SEC), unless there is an available exemption. In order to qualify for an exemption, it generally takes many additional hours of legal work. The JOBS Act added two (2) new exemptions for startups to expand their fundraising options: Rule 506(b)&(c) of Regulation D and Regulation Crowdfunding.
Title II – Rule 506 of Regulation D
On September 23, 2013, Title II of the Jumpstart Our Business Startups (JOBS) Act became effective, allowing businesses to publicly advertise their need for funding for the first time in eighty (80) years. The new exemption was created by splitting the previously existing Rule 506 of Regulation D into 506(b) and 506(c).
Rule 506(b), is the original exemption that allows startups to:
- Raise an unlimited amount of capital
- Raise capital from “accredited” investors and thirty-five (35) “non-accredited” investors
- Rely on an investor’s word that they are accredited, saving hours of paperwork to verify.
Since entrepreneurs are allowed to rely on an investor’s word that they are accredited, the main benefit here is a minimization in paperwork, such as, filing out Form D, etc. This is the eighty (80) year old, reliable exemption that most startups that use “seed funding” have used for many years.
If you want to use Rule 506(b) you cannot speak publicly, i.e. advertise online, about selling stock in your company otherwise you will need to use Rule 506(c).
Under 506(c) entrepreneurs can do the following:
- Raise capital through general solicitation, i.e. online
- Cannot raise capital from unaccredited investors
- Must confirm that all investors are accredited through “reasonable steps”
Types of Investors
Sometime you will hear the term “accredited” or “non-accredited” investor. Until 2016 only “accredited investors” were allowed to participate in making online equity-based investments.
To be an “accredited” investor, you had to:
- Have made over $200,000.00 a year for the last two years, or
- Have $1 million in assets, not including your primary residence
If you do not meet these requirements then you are a “non-accredited” investor.
Title III – Regulation Crowdfunding
Since Title III of the Jobs Act, was passed on May 16, 2016, non-accredited investors can to invest up to a certain amount on any deal they desire, alongside the venture capital firms. While the updated Title III regulations allow non-accredited investors to participate in crowdfunded investments, it is not without restrictions. The SEC has opted to place restrictions on how much non-accredited investors can invest over a twelve (12) month period. Your individual limit is based on your net worth and income.
- If you make less than $100,000.00 per year or your net worth is below that amount, you can invest up to either the greater of $2,000.00 or the lesser of 5% of your income or net worth.
- If your annual income and your net worth exceed $100,000.00, you can invest up to 10% of your income or net worth, whichever is less, up to a total limit of $100,000.00.
- A startup can raise up to $1 million in twelve (12) months via crowdfunding.
- Varying levels of public financial disclosure are required depending on how much money is raised, including:
- the price per share of stock
- financial statements
- information about majority shareholders
- public annual reports post-investment
The SEC wants to curtail the risk to non-accredited investors who may not be as knowledgeable about crowdfunding or investing in general. The SEC is limiting how much you invest so that they can limit how much you could lose if a particular investment fails.
What is the JOBS Act?
In an effort to ease regulatory hardships on smaller companies and facilitate capital formation, President Obama enacted the Jumpstart Our Business Startups (JOBS) Act on April 5, 2012. The JOBS Act allowed a new exemption under the Securities Act of 1933, as amended, for crowdfunding offerings. It amended the Securities Act, informally, referred to as Regulation A+, permitting companies to conduct offerings to raise up to $50 million USD through a shortened registration process similar to Regulation A. It allows higher triggering thresholds for SEC reporting obligations under the Securities Exchange Act of 1934.
What Types of Entities Can Use Crowdfunding?
- Limited Liability Companies
What are some crowdfunding Sites?
- Start Some Good
How Do I Get Started?
- Incorporate Your Business.
- Determine the best type of crowdfunding for your business.
- Familiarize yourself with regulatory requirements.
- Create a strong business plan and a video.
- Find the best online platform to host your startup, etc.
Contact us for any further questions.