Crowdfunding is a new and evolving fundraising alternative that marries social media and finance. With crowdfunding, entrepreneurs reach out to the “crowd”—typically their friends, customers, supporters and social network—for funding. The idea is that lots of smaller sums of money can take the place of one or two large investors or patrons.
Entrepreneurs create a crowdfunding campaign (usually consisting of written and video content) and publish it on a crowdfunding website or platform. The campaign provides basic information explaining their venture or idea, the amount of money they are seeking, what it will be used for, and what contributors (or investors) will get in return. The best campaigns inspire people to want to donate or invest. The crowdfunding platform typically takes a fee, from 3% to 10% of the money raised. CrowdsUnite is a review site to help you compare crowdfunding platforms.
There are two main types of crowdfunding—reward and equity.
1. Reward Crowdfunding
Reward crowdfunding is the most common form, popularized by websites like Indiegogo and Kickstarter. Entrepreneurs solicit financial contributions in exchange for rewards—those rewards could include a thank you note, t-shirt or a discounted product. Sometimes contributors are paying up front for a product that they would like to see developed—a form of pre-selling. Because there is no financial return promised, securities law do not apply. However, tax laws apply.
On Kickstarter along, more than $1 billion has been raised since 2009 for projects spanning film, music, food, gaming and technology. There are also rewards-based sites that specialize in niche markets, for example, Plum Alley for female entrepreneurs and ioby for community-based projects.
2. Investment Crowdfunding
Investment crowdfunding works the same way, except in exchange for a financial return—either a stake in the company through equity shares, interest payments on a loan, or a share of revenues. Crowdfunder, CircleUp and MicroVentures are all examples of crowdfunding platforms that use the equity model.
Because there is a promised financial return, securities laws come into play. The U.S. Securities and Exchange Commission (SEC) recently finalized rules under Title III of the Jumpstart Our Business Startups (JOBS) Act to open up opportunities for everyday Americans to participate in investment crowdfunding and invest in small businesses. Previously, investment crowdfunding was only open to accredited investors, defined as individuals with annual incomes of more than $200,000 or a net worth of more than $1 million.
Now, those earning more than $100,000 can invest up to $10,000 and those earning less than $100,000 can invest up to 5 percent of their annual income in a promising small business.
Real estate crowdfunding has become a hot crowdfunding market, as well. If your business has a real estate component – for example, a building you need to buy – sites like FundRise, RealtyMogul and Loquidity offer another option.
3. Debt Crowdfunding
Debt crowdfunding is another type of crowdfunding in which many investors give small amounts toward a larger loan that you can pay back over time. One example is Kiva, which offers interest-free loans through its platform. Like Kickstarter, Kiva requires that a loan receive full funding to disburse funds. Debt crowdfunding is similar to peer-to-peer lending platforms like Funding Circle. Another, Street Shares, connects veterans to interested investors through a peer-to-peer model.
Are you a good candidate for crowdfunding?
Ask yourself these questions:
- Do you have a loyal following or inspiring story?
- Do you have a good email list and social media presence?
- Are you looking to engage an audience of potential customers?
- Are your sales and (target) customers confined to one state? Then intrastate crowdfunding might be a good fit.
Pros and Cons of Crowdfunding
- Opens up new pools of capital that were previously unavailable to entrepreneurs
- Eliminates the gatekeepers: Many companies that have been turned down by banks, VCs and other gatekeepers have successfully raised money through crowdfunding.
- Flexibility: there’s a crowdfunding platform for every market niche and financial situation
- Promotion: Crowdfunding is as much about marketing as it is finance. It’s an opportunity to raise awareness, promote a brand and engage new and existing customers.
- Vet your idea: The crowd can validate your idea and provide valuable input and feedback for products or services that are under development, avoiding costly mistakes down the road.
- Resources: Crowdfunding campaigns require a lot of time and social media savvy
- Tax implications: crowdfunding platforms report funds raised to the IRS. While this remains something of a gray area, money raised on a rewards-based site may be considered taxable income (although that may be offset by expenses).
- Investor relations: Many business owners may not be prepared for having 100 or 1,000 new ‘owners.’ Although their rights may be limited, these investors may nonetheless demand time and attention
- Legal liability: Investors are allowed under the JOBS Act law to sue companies for misleading information or material omissions. It just takes just one disgruntled investor…
- IP protection: a crowdfunding campaign can expose your great idea and intellectual property for all to see—and copy