What’s long been a major fund-raising strategy in the entertainment industry has now been made available to companies in all industries and it’s seriously changing the way start-ups start up.
If you own a small business you may have considered crowdfunding at some point as an alternative source of financing. Online financing or crowdfunding is a relatively new concept and is another way the internet can support new businesses grow and develop.
But what do you need to know to get started raising capital this way? Before you dive into the world of crowdsourcing, it’s important to take a little time to educate yourself on the ins and outs and make sure that you and your company are legally protected. Read on to find out how.
What is Crowdfunding?
If you haven’t come across it before, here’s how it works: Companies and regular individuals register online on a number of crowdfunding platforms. The companies then create profiles to pitch their idea to the masses. People can donate small sums of money to the project if they are convinced by the idea or the entrepreneur. People who donate usually do not expect anything in return besides small gift tokens when the project is successful.
Another form of online financing is Peer-to-Peer lending, which is a way for individuals to access loans set at specific interest rates from other individuals offering money on the same platform. These P2P platforms must comply with local state and federal laws and a lot of services likeProsper ensure that they do so.
One of the largest crowdfunding websites in the world is Kickstarter. Everything from the Pebble smartwatch to the Oculus Rift virtual reality goggles have been seed-funded through Kickstarter. Since 2009 a total of $1.5 billion has been invested in new ideas posted on Kickstarter.
The potential for this trend to develop into something substantial is very promising. But the law has not caught up with the fast pace of technological development just yet. Whenever new ideas get ahead of current laws and regulations,it’s important to be aware of current best practices.
What Are The Legal Issues Involved?
So the idea of gaining seed funding for a new business idea from generous people online may strike a chord with a lot of entrepreneurs, but what about the legal status of these investments? Well, all sales of securities to the public is regulated by the Securities and Exchange Commission (SEC) under US federal law. In other words people who give money to companies cannot expect any payback on their investment unless the company is regulated and approved by the SEC.
The laws are slowly beginning to adapt to this new and innovative way for ideas to be developed into full products and services with the help of the crowd. The Jumpstart Our Business Startups or JOBS act became law in 2012. The SEC was instructed to find ways to exempt crowdsourcing from restrictive provisions that disallow non-registered securities offerings by non-accredited investors. The provision was mentioned in the JOBS Act in 2012, but the SEC has yet to publish its findings. Some websites, such as RockThePost.com, claim they are allowed to offer securities to investors who are accredited by the SEC.
This shows that soon equity funding through online crowdfunding platforms may become reality. However, not everyone is convinced this is a good idea. Forbes columnist Eric Savits recently said crowdfunding equity investments was “a legal disaster waiting to happen.”
The trouble with equity investments is that investors usually expect some form of say in how the business is managed or operated. They are, after all, part-owners in the business once they invest. Here are some of the other issues which may crop up later:
- Small businesses do not have the resources to manage an extremely large base of investors. They cannot afford to have annual general meetings and quarterly reports the way big public firms regularly do. But without access or infrastructure for this vital information, investors may be skeptical about putting money on the table and only speculators may get involved in the risky venture.
- Crowdfunding equity investments may dilute the company’s ownership structure and discourage venture capitalists and big institutions from investing in the future.
- Relaxing regulations on crowdfunding may encourage misrepresentation and unethical behavior.Anyone who has witnessed the fall of Enron knows the potential disaster investments can bring if not regulated properly.
- Then there’s the issue of intellectual property. There have been cases of ideas being stolen when they’ve been posted on crowdfunding websites. Many of these online platforms offer protections for intellectual property of startup businesses, but it’s not a perfect system yet. Additionally, some entrepreneurs themselves are found guilty of copyright infringement when using images or material online which they do not have the right permissions to use.
All of these legal issues must be considered before you look for funding online. The potential for crowdfunding to develop into a mainstream and powerful source of financing is exceptional, and although we may not have all the legal nitty-gritty sorted out just yet, a growing number of projects have met with great success by looking to the masses for startup capital.