“Crowdfunding” is the relatively new concept of pitching an idea in a large forum – typically over the Internet – in an effort to find large numbers of individual investors who are willing to contribute nominal sums for start-up capital rather than seeking venture capitalists for whole amounts. Once limited to the arts and charities, a new law is opening up crowdfunding to small businesses, but there are risks. Entrepreneurs will have to disclose financials to the investor pool regardless of their contributions as well as file precise paperwork with the Securities and Exchange Commission. Also, companies must remember that all of this additional effort may result in nothing, because it may not attract any interest. For more on this continue reading the following article from TheStreet.
Small companies will soon have a new option to obtain financing through crowdfunding, but there are some cautions to consider.
The so-called crowdfunding term essentially means pooling resources or money together from a group. Under the Jumpstart Our Business Startups Act, or JOBS Act, small companies will have the ability to raise up to $1 million in equity on an annual basis through crowdfunding, without having to go through the rigorous disclosure process by the Securities and Exchange Commission.
To be sure there are a host of unknown answers regarding crowdfunding, but as more companies take to social media to tell their story and gain a following, the strategy could become a major player in the alternative financing sector.
Right now, crowdfunding is a popular tool for charities, artists, theaters and other organizations that essentially want donations. Through crowdfunding followers can show support, contribute and get behind an idea, but it's not actually an investment.
"To put that platform in the hand of business owners and allow them to be creative and allow them to tap local friends and family is just incredible news," says Lendio CEO Brock Blake.
Two often-cited crowdfunding sites are Kickstarter and Indiegogo. But the new law should open the marketplace for many more crowdfunding sites to be launched. It will also open the door to potential risks.
Already early crowdfunding backers are launching a self-regulatory organization to essentially act as a gatekeeper to accredited crowdfunding sites.
The Crowdfunded Intermediary Regulatory Association seeks to provide "investor protection and market integrity through effective and efficient regulation of those within the crowdfunding industry," it said in a press release last week.
"This is a great opportunity for many businesses that are ready to 'take that step,' such as those companies that are geographically at a disadvantage or not in proximity to venture capital firms," says Karen Kerrigan, president and CEO of the Small Business & Entrepreneurship Council. However, "businesses might be reading about this and hearing about this and saying 'Oh wow this is a ticket to the funding I have been looking for,' but there is a reality check here on these crowdfunding platforms you're going to have very tough audiences, in terms of investors."
On a positive note, companies and their owners will likely learn "what they need to do in order to raise capital," Kerrigan says.
"You have to be ready to go on these platforms in terms of disclosing financials. You [also] have got to have your act together in business plan viability in the marketplace. There are a lot of things that you're going to have to disclose and share to these investors. You can't expect to just throw something out there and say ... fund me," Kerrigan says.
As part of the last-minute investor protections added to the JOBS Act in the Senate, companies using crowdfunding methods "must still file some basic information with the [SEC], including the names of directors, officers and holders of more than 20% of the company's shares, plus a description of the business and its financial condition," according to The New York Times.
Companies will also need to be aware of the applicable disclosure requirements, which will depend on how much money they are seeking.
For an issuer seeking to raise up to $100,000, they will have to provide tax returns and financial statements certified by the company's principal. For those seeking up to $500,000, they will have to file financial statements approved by an independent CPA. For issuers seeking to raise more than $500,000, they will need fully-audited financial statements, says Barry Sloane, chairman and CEO of Newtek Business Services (NEWT).
"The companies that are seeking to raise money, they better be sure that this information is accurate," Sloane says.
Companies will also have to consider how much control do they ultimately want to give up? Investor accountability will be of the utmost importance. At minimum, the process will be rigorous and time consuming.
"Entrepreneurs and small business owners will quickly find out if they are crowdfunding-ready when they enter these platforms," the SBE Council's Kerrigan says. "Having investors carries added responsibilities -- it's not just your business anymore."
A third issue to consider: Crowdfunding is a not a panacea to small-business financing. Just because you put your business on a crowdfunding site, doesn't mean that investors will want to back it. The business needs to be sound, experts say.
Another issue is the investors themselves. There is the now the potential for unsophisticated investors to get in on something they may think is an opportunity.
"If you get a bunch of people who don't really understand your business that could be a huge problem," Lendio's Blake says.
This article was republished with permission from TheStreet.