Updated: Mar 24, 2020
Information on Crowdfunding
If you’ve heard of crowdfunding but are a little confused, you’re not alone. Crowdfunding is an evolving fundraising alternative that marries social media and finance. With crowdfunding, entrepreneurs reach out to the “crowd”—which could include their friends, customers, neighbors, supporters and social network—for funding. The idea is that lots of smaller sums of money can take the place of one or two large investors or patrons, and that technology can help streamline the process of collecting crowdfunded investments.
Sounds simple , right? But crowdfunding comes in different varieties, and that’s where things get a tricky. There are two main types of crowdfunding:
1. Donation/Rewards-based crowdfunding
2. Investment based crowdfunding.
Donation/ Rewards-based Crowdfunding
This is the most common type of crowdfunding, popularized by sites such as Indiegogo and Kickstarter. With these sites people can contribute money to artistic or creative projects, such as films, music or even podcasts. The artist or entrepreneur raising money creates a campaign, complete with an audio or video pitch, to persuade people to back the project. The campaign is posted on a web or social media site, along with varying donation and reward levels. For a $10 contribution, you might get a thank you note. For $25, a t-shirt. The bigger spenders get bigger rewards—maybe scoring an invitation to the launch party. Some contributors get simply the satisfaction of knowing they contributed to something they believe in.
Sometimes contributors are paying up front for a product that they would like to see developed. This could be new music from their favorite artist or some new design from their favorite apparel creator. This is a form of pre-selling.
Other Contributor use sites that are strictly donation-based, where you’re supporting a cause or an individual in need.
The important thing that you want to note here is that, in all these cases, there is no financial return, so securities laws do not apply—and that simplifies all the tax things!
This “micro-patronage” or rewards-based crowdfunding model has been wildly successful. On Kickstarter alone, over $2 billion has been raised since 2009. There are also rewards-based sites that specialize in niche markets, for example:
Barnraiser.us - for food/ farm to table ventures
Experiment.com - for scientific development of products ventures
Patreon – for Podcast, musicians and other creative works
Side note: Issa Rae was able to fund her " The Misadventures of Awkward Black Girl project through the Patreon crowdfunding platform.
I am a fan of rewards-based crowdfunding, but it has some limits. It’s often more suited for creative projects than for businesses Let’s face reality, we all need to make money, So that’s where investment crowdfunding comes in.
Imagine Kickstarter, but instead of a donation, you’re making an investment in a small business, with the potential to share in the upside and downside of that business.
This was a game changer as investment crowdfunding would be ushered in by the Jumpstart Our Business Startups (JOBS) Act, a bipartisan bill signed into law in April 2012. The landmark legislation updated the nation’s 80-year old securities laws and relaxed longstanding rules that made if difficult, if not impossible, for small, private companies to reach out to the public (meaning ordinary investors) for capital.
The JOBS Act allowed for two types of investment crowdfunding: one form that is open to wealthy investors only (known as Title II), and another that would allow any individual, rich or poor, to invest in private companies through crowdfunding (Title III).
History Behind The Securities Law
Stay with me this will only hurt a bit...
Securities laws were put into place during the Great Depression and have always basically said: if you’re wealthy, you can invest in anything you want. But if you’re not wealthy—that is to say, 95% of the population—then you’re pretty much relegated to publicly-traded companies.
The intention was to protect less wealthy and most vulnerable investors. Publicly traded companies were required to disclose comprehensive financial information on a regular basis—those are the massive quarterly reports and filings that companies publish but few people ever really read. The idea was that investors would be armed with the information they needed to make an informed decision and avoid scams and other investing missteps.
Those rules have stood for decades, but times and technology have changed. The Internet makes information way more accessible than it was in the 1930s. Also the cost of going public has soared, putting it out of reach of all but the largest companies. Lawmakers over the years carved out exemptions to the rules, namely Regulation D, Regulation A and Rule 147 (also known as the intrastate exemption). But these exemptions also require a fair amount of costly legal and accounting work. The one time it’s absolutely okay and easy for private companies to get funding from regular (non-wealthy) investors is when they have a substantial, pre-existing relationship with those people—in other words, friends and family. But that can be a bit of a gray area, too. And not everyone has a rich uncle to go seek an investment from.
The motivation behind the JOBS Act was to update our ages old securities laws for the Internet age and make it easier for smaller companies to raise capital.
Accredited Investor Crowdfunding
Title II made it legal for private companies raising money from investors to come out of the closet and announce it. Sounds like a no-brainer, but before the JOBS Act, there were strict rules about how much a company seeking investment could say, and to whom. That was clearly a problem: it’s kind of hard to raise money when you can’t tell anyone. Title II does away with that restriction, allowing companies to freely advertise the fact that they are seeking investors— they can announce it at a conference, advertise on the radio, or blast it put on the web. This is known as “general solicitation.” Companies raising money this way use Regulation D Rule 506(c), a new securities exemption that allows for general solicitation.
But there’s a catch. While companies can widely advertise their fundraise under Title II, they can only accept money from accredited investors. (An accredited investor is defined as a person with $1 million net worth, not including primary residence, or with $200,000 in income for the past two years, or $300,000 for a couple). For that reason, Title II has been called “rich man’s crowdfunding.”
Title II rules were officially adopted by the S.E.C. in July 2013, and dozens of crowdfunding portals today focus on accredited investor crowdfunding. Some sites, such as Fundrise, Realty Mogul and Patch of Land, focus on commercial real estate. All told, more than 8,000 companies are estimated to have raised money via Title II through 2020.
Title III is the truly revolutionary centerpiece of the JOBS Act. Known as the crowdfunding provision, Title III makes is possible for small companies to raise money from the general public—wealthy, not wealthy, friend or stranger—as long as the investment takes place on a web site operated by a traditional broker-dealer or an S.E.C.-sanctioned crowdfunding portal, and certain other requirements are met.
Specifically, the law allows companies to raise up to $1 million in a 12-month period from the public. Investors are capped at the greater of $2,000 or 5% of their income, if their annual income or net worth is less than $100,000.
As noted by reseach group “The State of working america”:
The final rules also impose a limit on how much those with an income or net worth greater than $100,000 can make: they are limited to $10,000 per year or 10% of their income or net worth.
Regulation A+ “Mini-IPO”
Another piece of the JOBS Act that fulfills the ideal of mainstream crowdfunding is Title IV, also known as Regulation A+. It falls somewhere between small-scale crowdfunding and a full blown IPO (initial public offering). Under the Reg A+ laws, which went into effect in June 2015, companies can raise up to $50 million dollars (with audited financials and ongoing disclosure requirements, but no state-by-state review), or up to $20 million (with no audited financials required, but registration in each state the securities are offered).
In both cases, they can freely advertise the offerings and raise money from both accredited and non-accredited investors. Companies must also register with the S.E.C., although the process is slightly less onerous than a full blown IPO. For these reasons, Reg A+ is considered the “mini-IPO.”
Title IV updated a little-used federal exemption called Regulation A, dramatically boosting the amount that can be raised (from $5 million to $50 million) and addressing some of the hurdles, such as dual registration with states, that kept companies from making use of it.
A more attractive Reg A+ promises to bring new opportunities for people to invest in high growth potential companies at an early stage. Imagine if Facebook or Etsy had this option instead of going public (where only Wall Street insiders get in on the pre-IPO price)? These companies might have reached out to their customers and supporter base for funding instead. That said, Reg A+ is likely to be too costly for Main Street-type businesses that have more modest funding needs.
I hope this information brought some light to those that needed it, and maybe provided some options to those of you contemplating startups or creative ventures. The important thing to remember is that if given the opportunity to go big, you don’t try to do it alone. Understand and utilize all the tools at your disposal.
Lastly, don't be ashamed to ask friends, family and the community to invest in you. There is a switch in your mind that has to be turned from thinking “you're begging for money”, to “you’re providing an opportunity”. Investing has risk but is also one of the best vehicles for wealth creation. know that as you forward the discussion in your household and your community, you are changing people's perspective on what is possible.
- Trader Dre
Credit to “The State of working america” for data on Black wealth