What Exactly is Crowdfunding?

Crowdfunding, the use of online platforms for investment syndication, has exploded in popularity in recent years – both as a tool and as an industry. Recent estimates indicate that crowdfunding platforms raised an excess of $5 billion in 2013 alone, nearly twice the amount raised in 2012. This explosive growth will likely continue as crowdfunding platforms receive increasing media attention and gain broader investor acceptance.

Entrepreneurs, of course, will leverage every viable investment source to fund their start-ups. If you’re a start-up founder, no doubt you’ve heard the buzz about crowdfunding. But how much do you really know about this dynamic – and constantly evolving – new investment opportunity?

We’ve been actively involved in the growth of crowdfunding. Having served as counsel to industry-leading crowdfunding platforms and fast-moving start-ups, we have an informed perspective on this evolving industry. In this post – the first in a series that will examine different aspects of crowdfunding – we’ll provide an introductory overview of crowdfunding for start-up founders.

Types of Crowdfunding

Reward-based: Backers pledge financial or other support in exchange for some reward, e.g., the company’s new product or release (NOT in exchange for any equity or share in the company).

Donation-based: Backers support a cause-based organization or a particular (often charitable) effort in exchange for goodwill or personal recognition.

Equity-based: Backers invest funds in the company in exchange for actual ownership of equity share(s). Equity crowdfunding is the more viable option for most start-up founders.

Equity Crowdfunding

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups (“JOBS”) Act, legally clearing the way for start-up companies to raise money (up to $1,000,000) from the general public in exchange for unregistered securities. This legislative endorsement of equity crowdfunding radically expands both investment opportunities for the general public and access to capital for start-ups and other small businesses. Entrepreneurs are now legally authorized to publicly seek funding for their companies, while family, friends and the general public can fill the role of capital investor in these start-up ventures.

Waiting for Regulations

While the industry opportunity for equity crowdfunding is massive – analysts expect a $17B global market by 2015 – the boom must await related regulations from the U.S. government. According to the Securities Act of 1933, entities may not sell securities unless they are registered with the U.S. Securities Exchange Commission (“SEC”). Although the JOBS Act provides an exemption to this requirement, actual implementation nonetheless awaits SEC changes to its current regulations, which should take place later this year. Additional regulations to Titles II and III of the JOBS Act, expected in Q3 2014, will clear the way for the general public to invest, with certain limitations, through registered brokers of lending portals.

Stay tuned for future posts in this series: on crowdfunding for real estate, opportunities and pitfalls of crowdfunding, and the state of the crowdfunding industry.

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