From Crowdfunding To Crowdinvesting

Crowdfunding has become a fairly well-known and steady success, funding all kinds of projects from cancer-fighting supercomputers to alternatives to Teflon cooking surfaces to new albums from multinational recording artists and small local bands.  It is absolutely a viable tool these days for any startup that is attempting to raise capital.

You may, however, ask why the crowdsourced funding model has been on a donation-basis only, with the donor often getting some sort of perk from the project that has met its funding goals.

Why have these funds not been raised as investments, in which the parties supplying funds stand to be compensated and expose themselves to risk?  The simple answer is because it was not legal in the U.S. where Federal securities laws have long governed investing.

In the Spring of 2012, President Obama passed an act that will alter this paradigm with the launch of the JOBS Act which is short for Jumpstart Our Business Startups.  It is now “possible” for anyone to receive company equity in exchange for investing even very small sums of money.

We emphasize possible because until the SEC issues it’s regulations it’s an exemption that isn’t really available yet.  They are still working on implementing regulations that cover elements of the new law such as limiting investments to 5 or 10 percent of an individual’s income depending on whether they make more or less than 100k annually.

There are also requirements in the law meant to ensure that companies raising money provide clear and transparent information to potential investors such as:

  • Registration & incorporation documents
  • Name of directors, officers and stockholders
  • Description of business
  • Prior year tax returns
  • Financial statements
  • Intended use of proceeds, target amount and deadline
  • Share price
  • Description of ownership
  • Outstanding securities of the company

If raising more than $500k it appears that the company will also need to have financial statements audited, which can be costly.

The upside for startups is that it may remove a number of obstacles and provide an easier path for them to raise seed rounds from the general public.  Without financial backing it’s all too true that a great idea often stays just an idea, with financial backing, it can become a great company.

Any investment is a risk and the odds of you investing in the next Facebook or Dropbox are pretty slim, however the odds of winning the lottery are about one in 175 million so the question is where you want to put your own money if given the choice.

Despite the risks of many startups and crowdfunded projects, there is an inherent benefit to the success of the actual company in using distributed pool model vs. traditional investment.

When a company takes investment from a small group of investors, those investors invariably own a larger percentage of the company individually; and as such can dictate their positions more directly as opposed to individuals with very small ownership positions.

More importantly however is that when someone has invested in a company they are also invested in that companies success.  While it’s true that 10 accredited investors can use their connections and influence to help your company succeed, imagine what 10,000 crowdfunded investors can do for the growth of your startup?

Hopefully, we will see an influx of money headed to startups with innovative solutions to all sorts of problems.  Furthermore, we may also see many people get a start in investing with this model who would not traditionally be in the same crowd as venture capitalists.

Whatever the future holds for crowdinvesting, follow us for all the latest developments and advice for startups.

 

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