Crowdfunding is the latest buzz to hit the entrepreneur community, but no one really knows how it is going to work. What we do know is that it will allow people like you and me (non-accredited) investors to use our money to help small businesses to start or grow. The problem is that the funding entrepreneurs need to prove, start and grow their ideas into companies has been at a premium since 2008. The question now is whether the excitement will translate into a meaningful solution.
The turn of the century already saw a slow down from the tech investing of the 90’s, but when the recession hit, bank funding ground almost to a stop. Where could the entrepreneur go to seek funding for their idea or startup?
According to the Securities and Exchange Commission (SEC), only a qualified investor is allowed to put their money at risk by investing in a business project, whether it is funding a startup, a prototype, an expanding an existing business or really any other business activity.
A qualified investor is, in short, someone who is financially sophisticated and has a reduced need for the protections provided by the government. The government sees the people that fall into this category as having a net worth (not including their home) of over one million dollars, or someone who has had an income of $200K or better for the last two years or someone who is a general partner, executive officer, director or related combination thereof for the issuer of the security being offered.
These investors are considered to be fully functional and not subject to the restrictions of the SEC. f you don’t know people like this personally, you are usually out of luck as you have been unable to advertise to the general public in an attempt to reach these investors.
Another problem the entrepreneur has been seeing lately is that since 2008 the investment community has shied away from taking on the risk they tolerated before. Even now, in 2012, few investors are willing to risk money at the prototype, proof of concept stage. They want to see proven products with customers and sales before they show you the money.
This means that 99% of the entrepreneurs who need funding to prove their idea, begin manufacturing their product or other wise grow their business are going without.
The Jumpstart Our Businesses Startups Act (the JOBS Act) that was signed into law by President Obama in April is changing the landscape. The act is designed to make it easier and less costly for smaller companies to raise capital in the United States. Although we are still waiting for the details of the regulations from the SEC, there are broad definitions already established by the Act itself.
The maximum you can raise is $1MM in 12 months, and there is no limit on the assets or income of the investor. For the funded companies, there are different levels of disclosure required and different levels of financial auditing based on how much you raise.
- $0 – $100K – financials can be internally signed off by an company officer
- $100K – $500K – financials must be reviewed and signed off by an accountant
- Over $500K – requires audited financials
Although there is no limit on the assets or income of the investor, there are guidelines for investing. Those with and income of $100K and above can invest as much as 10% of their annual income. Those that make less than $100K are limited to 5% of their income to a maximum of $2,000.
The Act allows for general advertising, and should a problem arise that leads to a lawsuit, the investor can only recover the amount of money originally invested. Again, the SEC will be establishing the rules on how this money can be collected, who can collect it and the requirements on the companies soliciting and receiving the funds.
Until then, people are taking their best guess and overwhelmingly expect it to resemble the existing crowd funding sites for charities and other non-profits like Kiva.org (3rd world micro-lending) or donerschoose.org, (allowing teachers and educators to post worthwhile projects for funding).
Another site worth looking at is kickstarter.com where clearly defined creative projects with a tangible final product are posted for funding. Funding can take the form of a pure donation, as pre-sales of a product or in return for a reward or future benefit of some kind.
The important thing to understand about crowd funding is that, for the most part, the majority of your funding will be coming from your family, friends and neighbors, and their family and friends. Although you will be able to advertise, the people most likely to invest in you are those who already know and like you. So the success of crowdfunding depends on your network of friends and ability to make your opportunity known. Whether this is enough to break the current funding log jam, will be seen. Regardless, this is an exciting new avenue for start ups.
For more information; go to www.startupcalifornia.org. There you can increase your knowledge about this new opportunity and watch as this historic moment unfolds.