For many startups, a significant barrier to success is an inability to fund the business's early capital needs. Capital can come from many sources, and one approach to raising capital that has been in the spotlight recently is a method known as crowd funding.
People use the term crowd funding to refer to many things, but at its core, crowd funding is the process of reaching out to — and raising smaller amounts of money from — a large pool of investors (i.e., the "crowd").
In this way, crowd funding differs from traditional capital-raising techniques such as angel investment, where capital would come from far fewer large investors with whom the company has some pre-existing relationship. This article will touch upon three variations of crowd funding.
First, there is nonequity-based crowd funding. In this form of crowd funding, the company takes in donations from backers and, in return, generally provides perks or rewards. One common technique is to offer reduced-price pre-sales of a product that the company intends to develop and sell. In other cases, some backers get involved simply to feel connected to a company or product that appeals to them. Important from a legal perspective, backers do not receive any ownership interest in, or other securities of, the company. Sites such as Kickstarter, Indiegogo and RocketHub are operating as online portals for nonequity crowd funding.
A second crowd-funding approach, albeit one that requires more legal legwork, is to use a new provision in the securities laws that allows a company to use general advertising and solicitation of investors to raise capital.
A company may, under certain circumstances (and by complying with the applicable rules) sell securities without having to go through the costly process of registering those securities with federal or state securities authorities. If this sounds too good to be true, it very well might be. One significant drawback is that sales can only be made to so-called "accredited investors," which generally means wealthy individuals who satisfy asset or income qualifications, and certain other investors that meet specific financial guidelines.
Moreover, under rules proposed by the Securities and Exchange Commission, certain legends and disclosures would need to be included with any general solicitation materials, and the company would need to make a filing with the SEC and submit its solicitation materials to the SEC before beginning the offering.
The third variation of crowd funding, which would permit a company to raise capital by selling its securities to nonaccredited investors (i.e., even those investors who do not meet the financial thresholds discussed above), has many in the startup world excited.
It is important, however, to note that it is not yet a viable option because the SEC rules that would permit it have not yet been finalized. Under rules proposed by the SEC on Oct. 23, "Regulation Crowdfunding" would permit many companies to accept investment capital through online crowd-funding platforms from nonaccredited investors, subject to certain dollar-amount caps on the total amount raised by the company and the amount invested by any one investor.
Additionally, all sales would have to be made through a qualified intermediary such as a registered crowd-funding portal, certain disclosures would be required and general advertising would not be allowed. Until the final rules take effect (which is expected to occur sometime in 2014), this form of crowd funding will remain unavailable.
While nonequity crowd funding is thriving and has appeal for some companies, equity-based crowd funding is still in its infancy. One thing that is clear is that regulators are taking a cautious approach, possibly to the dismay and frustration of many in the startup community. Time will tell whether crowd funding expands beyond a niche area and becomes a useful mechanism for many startups and young companies to overcome some of the obstacles in meeting their capital needs.
Boot Camp for Startups
Please join me Dec. 18 from noon to 1 p.m. at the abi Innovation Hub where I will be expanding on this and other topics in a seminar titled "Crowd funding: What it is and Where it Stands."
This will be the third of nine monthly seminars in the abi's "Launch Series: A Boot Camp for Startups." To register, go to: www.eventbrite.com/e/the-launch-series-a-boot-camp-for-startups-session-3-tickets-9537327403.
If you're unable to attend the Dec. 18 presentation, I'm happy to answer your posted questions at www.unionleader.com/expert or http://www.abihub.org/ask-the-expert.
Matthew H. Benson is an attorney at Cook Little Rosenblatt & Manson in Manchester, where his practice focuses on representing startup and other entrepreneurial companies with various business and commercial matters. He can be reached at firstname.lastname@example.org and followed on Twitter @matt_benson.