Crowdfunding Basics - An overview

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March 31, 2016
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This blog post is the first in a series of three articles by Millyard Tech Law, PLLC exploring the use of crowdfunding for funding a small business.  The information provided is intended to provide an overview of the subject and is not a substitute for legal or business advice.  We encourage you to consult with a SBDC business advisor to explore whether crowdfunding is right for your business. 

 

What Is Crowdfunding?

Crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people primarily over the Internet.  There are two main types of crowdfunding:  rewards-based crowdfunding and equity crowdfunding.

Rewards-based crowdfunding allows entrepreneurs to pre-sell a product or service or to launch a business concept without incurring debt or selling equity.  Supporters receive rewards, such as discounts off the product or service once it is released, in exchange for supporting the project now.  Platforms such as Kickstarter and Indiegogo are frequently used for rewards-based crowdfunding initiatives.

Equity crowdfunding allows entrepreneurs to sell small amounts of stock or other equity in their companies to raise capital.  Prior to the passage of the JOBS Act, equity crowdfunding was not permitted under federal securities laws unless done through specific exemptions, such as in cases where the offer was restricted to residents of just one state.  New regulations that go into effect as of May 2016 remove these old limitations and allow businesses to sell securities across state lines without the requirement of a burdensome registration process as long as the federal crowdfunding regulations are followed.

There are also charity crowdfunding sites, such as gofundme.com, but we are limiting our discussion here to rewards-based crowdfunding and equity crowdfunding as the main types used by small businesses.

 

What Are the Benefits of Using Crowdfunding?

Many proponents will tell you that crowdfunding is revolutionary because it democratizes access to capital.  What they mean is that by allowing ordinary people to contribute to projects and businesses that they care about, we have a greater number of people weighing in on what innovations are truly important for societal advancement, rather than a small group of private investors whose investment decisions in startups are driven mainly by return on investment. However, beyond this lofty societal good, there are some practical benefits to crowdfunding.

  • If your business is not in the technology, pharmaceutical/medical or alternative energy industries, getting the attention of angel investors and venture capitalists can be exceedingly difficult.  Even within those preferred industries, statistics show that women-owned businesses receive less funding than businesses owned by men. Crowdfunding can provide an alternative to competing with those “hot” markets or overcoming those gender biases for limited private investment sources.
  • A crowdfunding campaign can help you build an audience or consumer base for your product even before the product is released.  Investors who are excited about your product and have contributed to your business are likely to use the product and tell their friends about it as soon as the product is launched, and who doesn’t want strong sales numbers coming out of the gate?
  • In addition to becoming a user of your product or service, crowdfunding investors can become contributors to your business by giving you access to their networks to support your success.  Of course, this requires you to develop good, trusting relationships with your investors after the campaign closes but if you put in that effort, then the rewards of expanding your current business network many times over may be open to you.

 

Crowdfunding Success Requires Good Strategy

It would be a mistake to think that the benefits of crowdfunding don’t require a great deal of work.  Regardless of whether you move forward with rewards-based crowdfunding or equity crowdfunding, any crowdfunding platform will require you to receive commitments for 100% of the amount you seek to raise before your campaign closes.  Failure to raise the full amount will result in the campaign and all commitments being terminated and your business will receive nothing. 

Just how difficult is it to raise money through crowdfunding?  In February 2016, Kickstarter reached its 100,000th funded campaign out of a total of over 281,000 projects that have sought funding since the platform launched in 2009.  This means that the success rate for crowdfunding on Kickstarter is only about 36% (slightly above the industry average).  Equity crowdfunding will not begin until May 2016 and so there is no current data on success rates; however, it is reasonable to assume that success rates will be comparable to rewards-based crowdfunding data.

For that reason, in order to maximize success, two things are critical for a successful crowdfunding campaign.  First, you need to have a business plan.  A good business plan helps to show potential investors that you understand your market, have a reasonable strategy for success and that you are “a good bet” for their investment dollars. 

The second thing that you need is a good marketing strategy to raise awareness about your campaign.   Crowdfunding is all about selling people on your vision. How well you tell your story is critically important.  You may want to enlist the help of a production company to create a demo video of your product.  You will also want to develop a plan for reaching out to reporters in relevant media markets to cover the launch of your campaign. If using equity crowdfunding, you should speak with an attorney as soon as possible to make sure that you have the proper capital structure for offering stock or membership units to new investors.

Over the next few weeks, we will delve into more detail about when and why to use rewards-based crowdfunding and equity crowdfunding as a way to raise capital for your business.  Stay tuned!

 

Would you like more information on equity crowdfunding?  Check out this e-book Getting Ready for Crowdfunding from Millyard Tech Law, PLLC.

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