The Ultimate Crowdfunding Guide

Crowd funding or crowdfunding (alternately investment crowdfunding, securities crowdfunding,  crowdinvestingcrowd financing, debt crowdfunding, crowdlending or equity crowdfunding) describes the collective effort of individuals who network and pool their resources, usually via the Internet, to support efforts initiated by other people or organizations. Crowdfunding also includes Peer to Peer Lending but has recently been re-labled as “Marketplace Lending” as a growing number of direct lending platforms are using institutional money or their own balance sheet to finance loans. Crowdfunding is used in support of a wide variety of activities, including, businesses, disaster reliefcitizen journalism, support of artists by fans, political campaigns, company funding, movies or software development, and scientific research.

Types of Investors

In the discussion of crowdfunding there are generally two types of investors: accredited investors and non-accredited investors.  These two groups operate by differing rules when investing.  In general, if you make less than $200,000 a year or are worth less than $1 million you are a non-accredited investor, although there are more complex rules that define these two groups.

What is an accredited investor?
What is a non-accredited investor?

The reason crowdfunding is an emerging topic in the United States is due to the JOBS act enabling non-accredited investors to invest in companies via crowdfunded offerings.  This means average citizens can contribute capital to companies without those companies having to deal with the typical bureaucratic overhead of selling stock on typical stock exchanges.

Types of Crowdfunding

 

Donation Crowdfunding

This is the most popular type of crowdfunding at this time. Donation crowdfunding has two types: rewards crowdfunding and charity crowdfunding.

Rewards Crowdfunding

Rewards-based crowdfunding is where contributions are exchanged for current or future of goods or services.  Individuals or companies who launch campaigns may compensate contributors with something like a t-shirt, a copy of whatever they’re building or even just a thank you.

Rewards-based crowdfunding is perhaps the most prolific form of crowdfunding currently taking place in the US.  Kickstarter and Indiegogo facilitate Anyone can go create a web page on these sites and pitch an idea.  A famous example of this is the Pebble watch.  Pebble used Kickstarter to pitch their idea: a relatively inexpensive e-paper watch that could be customized with apps to do things like display calendar notifications and emails.  They outlined  their idea on Kickstarter, made a video about the product and set a goal of $100,000 to complete R&D.  A donation of $100 earned you a promise that you’d receive the watch when they are done.  Different donation amounts had different rewards attached.  You could even donate $10,000 for 100 watches!

Had the $100,000 goal not been met, the donors would get their money back and everyone goes on their merry way.  Specific rules on funding vary by web site.  In the case of Pebble the goal was met, so the money was transferred from Kickstarter to Pebble.  Kickstarter charges a 5% commission.  Pebble is now obligated to give everyone what they paid for.  By the time the campaign was over Pebble had collected $10 million, or 100 times their initial goal.  Pebble now has the capital they need to create the product and they’ve already tested the market.  They’re off to the races.

Appropriate for: Projects in the arts (movies, art, music, etc.), companies looking to test markets, charitable groups and causes

Charity Crowdfunding

Donation crowdfunding takes place when an individual, company or organization accepts charitable donations.  Pretty simple, right?  This has been taking place for a long time, albeit it may not have always been called “crowdfunding.”  Wikipedia, the Red Cross, political parties, etc. all participate in donation-based crowdfunding.

Appropriate for: Nonprofits and causes.

Investment Crowdfunding

Investment crowdfunding when the crowd exchanges money for securities. There are two types of investment crowdfunding: lending crowdfunding and equity crowdfunding.

Debt Crowdfunding

Lending crowdfunding is when a crowd lends money to an individual or company with the understanding that the loan will be repaid with interest.  This is the methodology behind peer to peer lending sites like SoFi, FundingCircle, Lending Club and Prosper.  These sites facilitate crowdfunded loans to individuals for purposes like home improvement and debt refinancing. Debt-based crowdfunding has grown rapidly as institutional capital has capitalized on the superior risk adjusted returns generated by direct lenders. P2P lenders in some countries have re-labeled their platforms as “Marketplace Lenders” to reflect the shift from small investors to large ones. Some online direct lenders use their own balance sheet to finance individual loans.

In the UK there is a product called “Mini-Bonds”.  Similar to traditional bonds, Mini-bonds allow issuing companies to crowdfund unsecured debt at competitive rates.

One risk of this type of crowdfunding is default.  Every site will have their own policy on default and investors should understand these policies in order to protect themselves.

Appropriate for: Companies and individuals planning on multiple rounds of funding, companies who do not want to part with equity

Equity Crowdfunding

Equity crowdfunding is crowdfunding where the exchange is company equity, or ownership, and not goods or services.  The idea is very similar to how common stock is bought and sold on the stock market.

In the United States, there are three exemptions which allow for equity crowdfunding to occur.  Each of these was legalized under the JOBS Act. In most other countries a single exemption provides for online solicitation for exempt offerings to occur.

Title II Accredited Crowdfunding

This is a change in Regulation D. Under 506(c), a company may generally solicit or advertise investment opportunities in certain private placements. In 2014 approximately $1 trillion in private placements, under Regulation D, took place in the United States.

SEC Fact Sheets Under Title II Regarding General Solicitation on Private Offerings

Title III Retail Crowdfunding

An issuer may raise up to $1 million from both accredited and non-accredited investors.

SEC Fact Sheet on Final Rules of Title III of the JOBS Act

Title IV Regulation A+

Described as a mini-IPO type structure, there are two separate segments of Regulation A+.  Tier I allows an issuer to raise up to $20 million but they must submit to state Blue Sky Review. Tier II allows an issuer to raise up to $50 million and state review is preempted. The issuer must adhere to additional disclosure requirements such as audited financial statements.

SEC Fact Sheet on Final Rules of Title IV of the JOBS Act