Two years ago not many people had heard of Crowdfunding. With enactment of the JOBS Act early in 2012 and the well-publicized success of many companies on Kickstarter and other portals, everyone is talking about Crowdfunding today.
Yet many entrepreneurs are still unsure how Crowdfunding works and whether it can help their businesses. That is largely because Crowdfunding is not just one thing. It is really at least four very different ways to raise money, each with its own rules, audiences, and strategies. For many entrepreneurs the question is not whether Crowdfunding is right, but which Crowdfunding is right.
Donation-Based Crowdfunding
On portals like Kickstarter, companies raise money in the form of donations. The company raising the money does not give up any of its stock or even promise to pay the money back. Sometimes the company offers tokens of recognition to its donors, such as a baseball cap or a free massage, but donors expect and receive little or nothing of value.
Don’t expect to raise a lot of money through donations, but if you need to raise $10,000 or $25,000 to get started it might be worth the try. Make a good video and tell a good (and truthful) story, and you might be surprised how many people want to help.
Product-Based Crowdfunding
Say you want to develop a new kind of mousetrap, or camera, or car. You might ask your potential customers to fund the development of the product.
Eric Migicovsky raised more than $10 million on Kickstarter to create the new Pebble watch, and gave a new watch to everyone who contributed $99 or more. Migicovsky says he initially wanted to raise just $100,000 and was as surprised as anyone when donations mushroomed.
With product-based Crowdfunding, your customer receives just the product. He or she does not receive stock or the right to share in your future profits.
Rule 506 Crowdfunding
For companies that need to raise a serious amount of money, the most promising form of Crowdfunding available today is an old form of raising money, but with a twist.
For many years, Rule 506 issued by the Securities and Exchange Commission has allowed companies to raise large amounts of money from “accredited” (meaning, fairly wealthy) investors. Today, web-based companies are springing up to bring old-fashioned Rule 506 securities offerings to a larger group of accredited investors – accredited investors lurking in the Crowd, so to speak. At best, these new companies offer entrepreneurs access via the Web to a very large pool of wealthy investors, a virtually unlimited amount of money, and a relatively simple and straightforward process.
The caveat is that some of the web-based funding companies seem to be pushing the envelope of what the law allows in ways that could theoretically expose the entrepreneurs to liability. Buyer beware!
JOBS Act Crowdfunding
Ironically, the kind of Crowdfunding created by the JOBS Act – where companies are allowed to raise up to $1 million by selling stock to a lot of small investors – has been overshadowed by the other kinds of Crowdfunding. That’s because, despite the publicity, real JOBS Act Crowdfunding is stuck in the starting gate waiting for the Securities and Exchange Commission to issue final regulations. The regulations were supposed to be in place by January 1, 2013 but haven’t even been proposed yet.
When the regulations are finally issued, probably by the middle of 2013, thousands of companies will race to the Crowdfunding “portals” envisioned by the JOBS Act, which even now are waiting to start business. Any company that wants to raise money should be prepared when the SEC finally flips the switch.
Questions? Let me know.
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