As we begin to pull out of the recession entrepreneurs are starting and expanding businesses at an accelerated pace. Unfortunately they are finding that traditional sources for raising capital are increasingly difficult to come by. Banks have tightened their lending policies. At the same time many seeking funds are suffering from poor credit ratings resulting from difficulties experienced during the recession. The convergence of these factors is a perfect storm that is creating opportunities for alternative lending and funding providers.
Crowdfunding poised to lead
The list of alternative methods for raising capital includes Crowdfunding, Peer to Peer Lending, Online Pawn shops, Micro-lending, Revenue Based Financing and more. While each of these can be a promising source of capital for small business owners, Crowdfunding seems to have generated the most buzz. A recent Google search on Crowdfunding turned up over 9 million results. Crowdfunding is not only generating some real buzz but also spurning a lot of questions and some confusion. Our goal here is to answer some of the key questions and help clear up confusion and misconceptions surrounding Crowdfunding.
How it works
The CROWDFUND Act allows companies to raise up to $1 million a year from individual investors. Investors and those seeking funding will be brought together by a middleman, either a broker or an Internet website. The brokers and websites will have to register with the SEC. It aims to protect investors by requiring brokers to register with the SEC and by limiting how much individuals can invest. For example, investors who have an annual income or net worth under $100,000 can invest no more than the greater of $2,000 or 5% of their annual income or net worth.
How it is different
Crowdfunding allows you to retain creative and operational control of your business while still raising significant equity capital. In contrast, traditional equity funding is severely tipped in the investors' favor, giving them the bargaining power in early stage ventures. This means they give you less money and take more of your company because you are the one in need, not them.
Another point of differentiation and side benefit of Crowdfunding is that it provides a new way to connect with fans and supporters like never before. This engagement leads to increased dialogue which in turn leads to better feedback, additional distribution channels and happier customers, making crowdfunding the gift that keeps on giving.
The two types of Crowdfunding
Probably the biggest area of confusion revolves around the type of funds being raised. Today crowdfunding for donations is legal and a growing means for funding projects, causes and charities. Post a creative project, favorite cause or charity and people make donations towards your endeavor. The key here is that donors don't receive any equity. As such it is not regulated by the SEC. There are a host of companies facilitating donation based crowdfunding including KickStarter (creative projects), CharityKick (fundraising based on social networking and a "Dare") and Razoo (fundraising platform for nonprofits).
In contrast, equity based Crowdfunding means each investor receives a piece of your business. This form of Crowdfunding is regulated by the SEC and will not be legal until the rules are put into place by the end of 2012. Expect a proliferation of companies coming online to help businesses manage the equity Crowdfunding process. Here are two sites to find more information: http://www.startupexemption.com or http://www.cfira.org
What is required
If you think equity based Crowdfunding, or any of the alternative methods for raising capital or debt financing is right for you, now is a great time to make sure your financial statements are in order. While the requirements will vary with the funding source and amount, small businesses seeking to raise money via Crowdfunding will be required to disclose certain legal and financial information. Disclosure requirements increase with the amount of capital raised starting with basic financial statements and tax returns and increasing to include audited financial statements.
What you can do now
You can't raise capital through Crowdfunding until the SEC puts into place the rules, regulations and restrictions that will govern the Act. These rules and regulations should be in place by early 2013. While the SEC is busy with their work, there are a number of actions you can take if you are thinking seriously about Crowdfunding for your business. Assemble your information package, build your potential investor list, develop your sales pitch and talk to your legal and accounting advisors.
Dave Heistein, founder of Profitwise Accounting says, "As a CPA specializing in the small business sector, I see some interesting opportunities in Crowdfunding for certain clients looking to raise capital. Like many things, the devil is in the detail and I would encourage anyone considering Crowdfunding to seek out expert advice and spend time making sure your financial statements are in good order."