Crowdfunding is big business these days. How big? According to an industry report by Massolution, crowdfunding numbers are expected to reach $34 billion this year. It’s a trendy and often fascinating way to gain financial support for a new entrepreneurial effort.
Let’s look at the two types of crowdfunding.
Rewards-based: This has been popularized by such platforms as Kickstarter and Indiegogo. “This is where people can pre-purchase products, buy experiences, or simply donate,” Chance Barnett writes for Forbes. “While this funding may in some cases go toward helping a business, funders are not allowed to invest and become shareholders via rewards-based crowdfunding.”
Equity-based: This “allows people to become shareholders in a company,” writes Barnett. “There are already thousands of companies online seeking and raising investment for their businesses online at sites like Crowdfunder.com and Circle Up. In equity crowdfunding, companies sell ownership stakes online in the form of equity or debt.”
Here’s a look at some of the trickier elements of both methods.
Investor management.
For those looking for equity-based crowdfunding, this can be a challenge. Communication on a business’ progress may be complicated, but there are ways to simplify it. Christina Desmarais writes about this for inc.com.
“Investor management is another potential source of liability and complexity that can distract you from running your business,” writes Desmarais. “How will the platform facilitate tax reporting requirements or the updates you’ll need to give the investors who have a stake in your company? Be smart and choose an equity crowdfunding platform that makes a large group of investors appear as a single investor, so you won’t have to deal with the hassle of communicating with backers on an individual basis.”
Client credibility.
Raising money and gaining interest in a business often takes networking among family and friends. A potential problem is that such support may not be sustainable going forward.
As John Mullins writes for entrepreneur.com, “Most ambitious entrepreneurs hope to create and build fast-growing companies. But customer traction from the crowd lacks both the credibility and repeatability of customer traction from those whose problems your business will actually solve going forward. Crowdfunded money from your family and friends — and, if you are lucky, their networks — is often provided for quite a different reason than the fundamentals of the idea: They love you! But real customers may not.”
SEC compliance.
There are two words that might make any entrepreneur shudder. But SEC compliance is a part of equity crowdfunding, so it can’t be something that is ignored. Moira Vetter writes about this for Forbes.
“Equity crowdfunding comes with regulatory responsibilities that may be too much for you to take on,” writes Vetter. “To the SEC, equity crowdfunding is the same as selling securities, and thus requires mechanisms to protect investors. For instance, under Reg A+ rules, you must file an offering statement with the SEC. This disclosure can be expensive to produce, especially for a business in need of capital. And, Reg A+ funding requires ongoing SEC reporting, and issuers (that’s you) are subject to FINRA (Financial Industry Regulatory Authority) review as well. Sound involved and unpleasant? It may be. An attorney should advise you on how involved this process may be.”
Intellectual property.
An entrepreneur will have to make a public pitch in order to gain interest in rewards-based crowdfunding. But how much information is too much? The last thing you want is to put a complete concept out for the world to see, only to then watch someone else snatch it from you.
“Rewards-based crowdfunding platforms often make campaigners use standard templates that involve sharing certain information,” writes Desmarais. “Would a required video expose too much about how your product works? Think about how much information you are comfortable sharing about your idea and know that equity crowdfunding platforms have a more in-depth due diligence process than rewards-based platforms.”