Crowd Funding: More Money for Small Business

Looking for ways to fund your startup? Join the crowd.

Traditionally, small businesses have gone to banks for loans, but that’s always been a tough sell. Banks often feel small business loans are too risky. And unless you’re an established business seeking to raise tens of millions of dollars, the stock market is too big and complicated. Granted, there are special programs like microloans for small business, but all in all, raising money has always been tough for entrepreneurs.

But there’s a new option on the horizon: “crowd funding.” If the term sounds familiar, you’ve probably heard of sites like Kickstarter, RocketHub and Indiegogo. They’ve been in the news recently for charity fundraisers and products people want to see.

Because of a new law called the Jumpstart Our Business Startups (JOBS) Act, funding portals like these and others will soon be able to offer small businesses something like a small-scale public stock offering: They’ll be able to raise cash directly from consumers in exchange for partial ownership.

In the video below, Money Talks News founder Stacy Johnson offers a quick overview on crowd funding and talks to a small business co-founder about how she might use it. Check it out, and then read on for more details…

As Stacy suggests, small businesses could soon use crowd-funding sites to raise capital, and small investors could theoretically get in on the ground floor of the next Facebook. Here’s what got it started and how it works…

The JOBS Act

The idea for the bill initially grew out of recommendations from President Obama’s Startup America initiative last year – and was drafted by Republicans in the House of Representatives. It received rare bipartisan support and passed in April.

The law does a lot more than allow crowd funding. It also loosens many business regulations and makes other ways to raise capital easier. The U.S. Securities and Exchange Commission, the part of the federal government responsible for watching over Wall Street and enforcing securities laws, is still trying to figure out how this new fundraising model is going to work and how to protect investors. They’re currently establishing rules. (You can comment on the SEC’s website or read what others are saying.)

It’s not clear what the rules will be or exactly when they’ll become effective, but since the law gives the SEC nine months to develop those rules, it will probably happen early next year. And we do know a few things already, based on the legislation itself…

• You can’t crowd-fund through your own website – only through approved portals.
• Funding portals can’t directly handle the money and will need to register as a broker, find one, or use a bank.
• They also won’t be able to make recommendations or promote particular projects, as some crowd-funding sites do now.
• Investors who make less than $40,000 a year will be limited to investing $2,000 a year. Those who make $40,000 to $100,000 a year will be limited to investing 5 percent, and those who make more are capped at 10 percent with a maximum annual investment of $100,000.
• Entrepreneurs who hold more than a 20 percent stake in the business they’re fundraising for will be subject to background checks by the funding portal.
• Businesses with fundraising goals of more than $100,000 will have to submit tax returns and financial records. Those looking for more than $500,000 will also have to have those professionally audited.

How crowd funding works

You can already see crowd funding in action, just not for small businesses. Right now, websites like Kickstarter (which has seen more than $200 million in pledges and funded about 20,000 campaigns) let creative people looking for capital list projects (ranging from products to music and art) with a financial goal and a time limit. People who want to support those projects can back them by pledging a donation of their choosing.

If the project reaches its goal in the set timeframe, it gets funded with all of the money it raised, minus a cut for the platform, even if it’s way in excess of the stated goal. If it doesn’t meet the goal, the project gets nothing and the backers keep their money.

(Not all funding platforms operate this way. RocketHub, for instance, lets projects keep everything they’re pledged regardless of meeting the goal. But for businesses, the model will probably be more like Kickstarter’s to protect investors.)

To encourage pledges, projects often offer incentives to donate by establishing several reward thresholds for people who chip in.

It’s all easier to understand with an example, so take a look at the Brydge for iPad. This is a project to mass-produce a detachable keyboard for iPads that makes them more like laptops. They set a goal of $90,000 and raised almost $800,000 from more than 3,000 people who thought it was a cool idea. Kickstarter took a 5 percent fee (about $40,000), and the Brydge team got the rest and went to work. The product will ship in October.

Those pledging money get no ownership in the business, but those who put up $150 or more will receive one of the first Brydge models for less than the retail price ($170). At higher levels, backers were promised special editions with speakers built in, or models “anodized in San Francisco Gold, laser etched with your name.”

And this is the big difference between the crowd funding you see today and what’s ahead. Starting next year, the incentive for investors will be equity: Investors will put up money and own a share of the company, just as they do in the stock market today. And businesses can raise up to $1 million a year this way.

Bottom line? A lot of this is still up in the air, but it’s an opportunity that until now small business owners could only dream of. It’s not going to be free money – the most successful current crowd-funding projects spend a lot of time planning and showcasing their ideas, coming up with incentives, and providing regular updates to backers. Pitching to lay investors will likely be very different – and potentially more difficult – than pitching to venture capitalists. In short, crowd funding will offer small business another avenue to raise money, but nobody’s saying it will be easy.

If you’re interested in learning more, Crowdsourcing.org will be hosting a free online seminar called “Is CrowdFunding Right for Your Business?” on Tuesday, July 10.