What is Crowdfunding? (and how can it help your startup?)

Crowdfunding gives startups a way to raise money from a large group of supporters or investors through online platforms. While donation- and rewards-based campaigns may help businesses fund projects or introduce products, securities crowdfunding allows eligible startups to raise investment capital under specific federal securities rules.

Key Takeaways

• Crowdfunding allows businesses to raise money from a large number of people online.
• Crowdfunding may involve donations, product pre-sales, rewards, or investments.
• Rewards-based crowdfunding and securities crowdfunding have different legal implications.
• Regulation Crowdfunding allows eligible companies to raise up to $5 million in a 12-month period.
• Regulation Crowdfunding offerings must be conducted through an SEC-registered intermediary.
• Companies conducting securities crowdfunding offerings have disclosure and other compliance requirements.
• Crowdfunding can also help startups generate publicity, build a customer base, and evaluate market demand.
• Startups should determine which fundraising method and securities exemption best fit their needs before soliciting investments.

 

Crowdfunding is an innovative way to raise money for a project by pooling small contributions from a large number of people.

 

It’s a simple idea that – when combined with the reach of the Internet – can lead to profound consequences. Barack Obama’s unlikely 2008 campaign was largely paid for by small contributions to his online crowdfunding machine. And Kiva.org – a crowdfunded micro-lending site – has helped over 1.9 million low-income entrepreneurs and students get small loans.

 

Crowdfunding has also helped thousands of small businesses and startups raise seed capital and fund projects via sites like Kickstarter.com and Indiegogo.com. These sites allow individuals to raise funding for a project from supporters all over the world. Until recent changes in federal securities laws, crowdfunding contributions were in the form of a contribution, a donation or a pre-purchase of a product.

 

Another form, known as securities or equity crowdfunding, allows qualifying businesses to raise money from investors in exchange for securities in the company. Because securities crowdfunding involves investments rather than donations or product purchases, federal and state securities laws may apply.

What Crowdfunding can mean for your startup

For some startups, crowdfunding may be necessary to bypass the angel and venture capital funding process. For example, in 2012, Pebble, a high-tech wristwatch company, raised over $10 million via a crowdfunding pre-production product sale campaign after failing to raise enough venture capital funding to develop their product.

 

In the past, an entrepreneur would be forced to convince one of a small number of bankers or venture capitalists to back their idea. Today, startup founders can reach people all over the world via email and social media. They can ask people they have never even met to contribute to their project in one of several ways.

 

Online crowdfunding campaigns can also benefit startups in ways beyond raising money. A successful campaign can generate word-of-mouth marketing, help a company build an early customer base, and provide valuable feedback about product features, design, pricing, and market demand. 

 

Rewards-Based and Securities Crowdfunding Are Different 

Traditional crowdfunding platforms helped popularize donation- and rewards-based crowdfunding. In these campaigns, supporters might contribute to a project, pre-purchase a product, or receive some other reward. They generally do not receive an ownership interest or other security in the company.

Securities crowdfunding is different.

In 2012, Congress passed the Jumpstart Our Business Startups “JOBS” Act to make it easier for startups to raise certain types of capital. The Crowdfunding exemption of the JOBS Act reworked some existing securities regulations around “Equity-based” crowdfunding.  The SEC subsequently adopted Regulation Crowdfunding, which became effective in 2016. 

Today, Regulation Crowdfunding allows eligible companies to raise up to $5 million during a 12-month period through the offer and sale of securities.

Because investors are purchasing securities, Regulation Crowdfunding is subject to specific legal requirements. Transactions must take place online through an SEC-registered broker-dealer or funding portal, and the company must provide required information to the SEC, investors, and the intermediary facilitating the offering.

Get Help With the Legal Implications of Crowdfunding 

Crowdfunding can give startups access to funding sources that were once difficult to reach, but the legal requirements can vary significantly depending on how the campaign is structured.

If supporters are simply donating money or purchasing products, the legal considerations are different from an offering in which investors receive stock or other securities.

If you have questions about the legal implications of raising money through crowdfunding or other forms of startup financing, JGPC Law can help you evaluate your options and understand the requirements that may apply.

Frequently Asked Questions

What is crowdfunding?

Crowdfunding is a method of raising money from a relatively large number of people, usually through an online platform. Campaigns may involve donations, rewards, product purchases, or investments in a business.

 

What is the difference between rewards-based and equity crowdfunding?

With rewards-based crowdfunding, contributors may receive a product, service, or other reward but generally do not acquire securities in the company. Securities or equity crowdfunding involves investors providing capital in exchange for stock or another type of security.

 

How much can a startup raise through Regulation Crowdfunding?

Under current federal rules, an eligible company may raise up to $5 million through Regulation Crowdfunding during a 12-month period.

 

Can a startup run its own securities crowdfunding campaign?

A Regulation Crowdfunding transaction must be conducted online through a single intermediary that is registered with the SEC as either a broker-dealer or funding portal. Startups must also satisfy applicable disclosure and other regulatory requirements.

 

Is crowdfunding exempt from securities laws?

Not simply because the investment is raised online. Regulation Crowdfunding provides an exemption from federal securities registration when its requirements are satisfied, but participating companies remain subject to securities regulations, including anti-fraud provisions.

 

Should a startup talk to an attorney before beginning a crowdfunding campaign?

Legal guidance is particularly important when a crowdfunding campaign involves selling stock or other securities. An attorney can help determine which securities exemption may apply and what disclosures, filings, and other requirements the company must satisfy.

 

The content presented in this article is for general informational purposes only. It is not, nor is it intended to be, legal advice. It does not constitute the formation of an attorney-client relationship. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.