Crowdfunding is the modern way for new startup companies to secure funding and move into the marketplace. For all of that, there are various laws (e.g., Title III of the JOBS Act) set in place to make it easier for startup companies to proceed.
In general, crowdfunding works similar to other forms of investment for startups or new ventures. This would be separate and different from funding through a financial institution or a select group of sophisticated investors. While those entities and individuals may have more experience and requirements, crowdfunding does not have the same requirements. Instead, the investments come from a pool of people who use an online service (e.g., Kickstarter, Indiegogo) to allow contributions. These individuals may not have the same experience as the more sophisticated investors, and the law, in certain cases, implements measures to protect the less-sophisticated investors.
There are two major methods of crowdfunding a new project. First, it is the mainstream method. This is where a company or organization gathers funds from potential consumers with only a promise to later put out the merchandise or perks for sale. The reward for the investors may be limited to smaller gifts, credit in a creative project, or a pre-order for the actual project. However, this may be a better approach for those projects that already have an established customer base. Furthermore, their success would be best seen with projects that have already made it most of the way through the development stage. This may help most entrepreneurs with starting up initial distribution channels, and infiltrating the marketplace through what are effectively pre-sales through the crowdfunding website.
The second type of crowdfunding is the recently approved method through Title III of the JOBS Act. Under this title, unaccredited investors can invest if either their annual income or net worth is less than $107,000, then during any 12-month period they can invest up to the greater of either $2,200 or 5% of the lesser of their annual income or net worth. If both their annual income and net worth are equal to or more than $107,000, then during any 12-month period, they can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $107,000. This is known as the “equity model.”
However, keep in mind that compared to the mainstream method of crowdfunding, this would force a company to distribute profits to its investors, and most likely would require consultation with a lawyer.
Furthermore, the portals for crowdfunding under this method are not exempt from liability. Also, by capping investment per individual, a venture capital investment firm may have to make up for those limits either with a higher volume of investors or alternative forms of investment such as banks or professional investors.
The risks and rewards can be complicated, and adhering to Title III as either a venture capital investment firm or crowdfunding portal will require speak with a crowdfunding attorney. This is especially relevant as this continues to be a newer area of law, with Title III only taking effect as of May 2016, and additional changes to be expected in the near future.
Regardless of what decision you make in the crowdfunding sphere, it would be prudent to consult with an attorney with experience in crowdfunding, as it is still a new area of interest, and one that startup businesses are taking advantage of to better compete in the market.
In order to speak with an attorney, you may contact us online or call 310-694-3034 for an initial consultation.