Q: Steve — What’s the deal with these new crowdfunding rules I keep hearing about? — Amir
A: It helps to think of crowdfunding as three distinct and different buckets.
In the first bucket is charitable crowdfunding. In this bucket you can find sites like GoFundMe, YouCaring, and DonorsChoose. These sorts of sites allow people to create campaigns that are not crowdfunding in the business sense, but rather a way for people to create and/or support a person or cause.
DonorsChoose for instance is a way to help a teacher with classroom projects and needs. On that site for instance is a campaign for Mrs. Antonio, looking for supplies to help her sweet 5th graders. On the GoFundMe site, there is a campaign for a beloved faculty member of the Springside Chestnut Hill Academy, Ms. Theresa Stewart, who needs help with medical bills. On YouCaring, I saw a campaign to help Liz Miller with her cancer treatments.
The second bucket is the sort of crowdfunding that most small business people hear and think about. On sites like Kickstarter, IndieGoGo, Teespring, and Kiva.org, entrepreneurs can list projects and get donors to help fund the dream. This bucket is also called rewards-based crowdfunding. Here, in exchange for a donation, the giver gets some sort of reward from the business – usually it is the business’ product.
The final type of crowdfunding is called equity-based crowdfunding and when you hear about changes in rules and laws, that is what is being referred to and that is what we are going to drill down into today.
With rewards crowdfunding, when someone donates to the cause, they get the designated reward. Essentially it is a way for a small business to pre-sell or test a product. While it is great when it hits, raising significant amounts of money this way is not easy.
That is one reason why equity crowdfunding is potentially so attractive. Equity crowdfunding is what it sounds like. The entrepreneur can sell, not products, but actual interest — equity — in the company. Donors essentially become angel investors.
That is both the promise, and the challenge, of the system. Selling equity on the open market is the same as selling stock, and that is where the Securities and Exchange Commission comes in. While equity crowdfunding was made legal several years ago with the JOBS Act, we have been waiting for the SEC to promulgate rules that would govern the process.
The new rules took four years to create and were finally introduced a couple of weeks ago.
Business can now sell stock to investors across equity crowdfunding sites like SeedInvest, AngelsList and Fundable. Previously, security laws mandated that only “accredited investors” (generally, people who made at least $200,000 a year individually or $300,00 if married) could invest in early-stage startups. The new rules relax such mandates and now small businesses can sell up to $1 million per individual, unaccredited investor in a 12-month period.
So this is good news for you the investor and you the entrepreneur, right?
Yes and no.
Undoubtedly it is a boon that startups can now crowdfund by selling equity. The third edition of my book The Small Business Bible came out a few years ago and in it I have a chapter on creative funding for businesses. Equity crowdfunding is not something I mention because it was not possible back then. It is great that entrepreneurs have yet another way to raise money.
But it is also likely true that the good ‘ol regular small business may have a tough time raising funds via equity crowdfunding. A lot of the buzz will probably go to high-tech startups.
It is equally true that you need to be careful if you are going to start investing in equity crowdfunded startups. Becoming an angel investor is risky.
But all in all, the bottom line is that the promulgation of these rules and the emergence of equity crowdfunding is a welcome addition to the business funding world.
Today’s tip: SeedInvest has a solid list of the risks involved in these types of investments, including,
► “Investing in start-ups will put the entire amount of your investment at risk.
► “The amount of return on investment, if any, is highly variable and not guaranteed.
► “It may be difficult to sell your securities.
► “For a startup to succeed, it will need to expand significantly. There can be no assurance that it will achieve this expansion.”