What is Crowdfunding?

There’s a new buzzword flying around entrepreneurial circles these days – Crowdfunding.  It’s cool, it’s new, it’s sleek, but what is it?  Discussions of it are confusing:

“It’s a growing phenomenon that’s changing the world”

“It’s illegal“

“It is happening now and it’s huge”

“You can’t do it yet”

What is going on?  Who can you believe?  I will try to bring some clarity to the contradictory mess of information out there, because – it’s all correct.

How can the statements above ALL be correct?  Simply this:  The new buzzword “Crowdfunding” is being used to describe two similar but different things.

Crowdfunding is essentially allowing large crowds of people fund projects or businesses with a small amount of money from each of them, rather than traditional small business funding, where a few people put in larger amounts of money.

Crowdfunding has been around for a long time.  The New York Stock Exchange is, essentially, Crowdfunding for large corporations.  Lots of people pay a little each to own equity in a large corporation.  Nonprofits have also always been Crowdfnded – the Preacher wants to deliver a product (the sermon and counseling, maybe some religious education), he passes the basket every Sunday and asks his backers (the congregants) to Crowdfund the Church by donating money to support the project.

So Crowdfunding is a familiar activity – so why the Buzz?  The Buzz is over new ideas and new laws that will allow small businesses, entrepreneurs, inventors, artists, etc. to use this powerful tool, where before it could only be used by large for-profit corporations and non-profits.

The confusion comes from the two different Crowdfunding models that are being talked about today – I call them Reward Crowdfunding and Equity Crowdfunding.

Reward Crowdfunding is already happening, and is a growing phenomenon that, in the words of Richard Bliss, founder of the Crowdfunding Academy, “Is changing every industry it touches”.   In Reward Crowdfunding, a person or small business funds a discrete project with a concrete deliverable by seeking backers on the internet.  The backers fund the project primarily because they are fans – fans of the project owner, fans of the artist, or even just fans of the genre.  In return for funding, the project owner offers the backers some tangible rewards.  These rewards are less valuable than the money pledged:  the idea is not to sell the rewards it is to raise funds to complete the project.  Rewards can be as simple as a thank you, or a telephone call from the project owner, or a signed copy of the final product.  The backers get only their reward, and never get any of their money back or any share of profits.  They have backed the project simply because they want to be a part of its success.  The project manager’s only responsibility is to deliver the rewards he promised – the money pledged is his to keep.

Reward Crowdfunding – because it does not involve the sale of “securities”, is legal and has been legal forever.  It is the internet that has allowed it to succeed – permitting project owners to reach out and find backers in a way that would have been impossible before.  And it is thriving.  The largest site for Reward Crowdfunding is Kickstarter (www.kickstarter.com).  According to Kickstarter “Since our launch on April 28, 2009, over $450 million has been pledged by more than 3 million people, funding more than 35,000 creative projects. “  That is amazing.  Kickstarter’s biggest competitor is Indie Go-Go (www.indiegogo.com).  It offers a slightly different take on Reward Crowdfunding.  Together, they will soon pass the $1 Billion in pledged funds mark.

Equity Crowdfunding is a bit different.  Rather than allowing you to fund discrete projects with the backing of your fans, Equity Crowdfunding allows an entrepreneur to raise capital for his business by selling shares in his company – securities – in the same way large companies raise capital by selling shares on a stock exchange.  The difference is one of regulation.  To sell shares on a stock exchange, a company must register their offering with the United States Securities and Exchange Commission as a public offering.  This is an expensive process that effectively forecloses this way of raising capital to any but the largest corporations.  There have always been exemptions from the registration requirements, but they have either not permitted advertising (especially on the internet) or restrict the types of investors who can invest to residents of a certain State or to wealthy investors.

Equity Crowdfunding will remove those restrictions, and allow small business to raise capital from anyone using the internet without going through the expensive registration process.  The business will be required to use an approved “Crowdfunding Portal” and make certain disclosures, but after that anyone can purchase that company’s shares and become a part of the business.  Investors will receive equity in the company, and a right to share in that company’s future profits.  They will be able to sell their shares later, similarly to someone who buys shares of Coca-cola or Microsoft on a stock exchange.

Equity Crowdfunding is, and has been, illegal.  You cannot do it, yet.   In 2012, Congress passed and the President signed the JOBS Act, which will permit Equity Crowdfunding in the United States.  The Act puts limits on the total amount a company can raise using Equity Crowdfunding, and on the amount any given investor can invest using Equity Crowdfunding – but it will be legal.  Before it can become legal, however, the SEC must issue regulations giving the details of how it is to be implemented.  Those regulations are expected this year – so Equity Crowdfunding is coming, ut it isn’t here yet.

Will Equity Crowdfunding succeed as wildly as Reward Crowdfunding has?  Who will use it and for what?  What will company owners have to offer Equity backers to get them to invest?  All these questions remain to be answered – what do you think?   Let us know.

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One thought on “What is Crowdfunding?

  1. Pingback: Crowdfunding by the Numbers On Business

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