It is easy to see the allure of crowdfunding as an option to raise capital for small business owners. Be aware, however, that there are several hidden pitfalls to raising capital through crowdfunding.
Choosing the best model: donation or securities
Donation crowdfunding involves backers donating varying sums of money to support a specific cause or project on websites such as Indiegogo, Kickstarter, or GoFundMe. In exchange for “donations” from investors, the entrepreneur promises to offer services, pre-order of products, and other creative packages. There is very little oversight and the online website serves merely as a facilitator for the transaction between the entrepreneur and the investors.
Securities crowdfunding is subject to far more oversight with the goal of offering more protection for investors. The SEC has passed rigorous rules to make all funding portals register before they will be allowed to facilitate transactions.
Critics of this method argue that these new rules could potentially cost tens of thousands of dollars.
New Regulation Crowdfunding rules
Adopted by the Securities and Exchange Commission (SEC), these new regulations will present new opportunities and obstacles when they go into effect on Monday, May 16.
• Issuers may raise a maximum aggregate amount of $1 million through crowdfunding offerings in any 12-month period.
• Individual investors, in any 12-month period, may invest in the aggregate across all crowdfunding offerings up to the greater of $2,000 or 5% of the lesser of annual income or net worth, if either annual income or net worth is less than $100,000; or 10% of the lesser of their annual income or net worth if both their annual income and net worth are equal to or more than $100,000.
• Aggregate amount an investor may invest in all crowdfunding offerings may not exceed $100,000 in any 12-month period.
The bottom line is that new Regulation Crowdfunding rules will allow anyone, accredited or non-accredited, to invest in a U.S.-based company. Credit scores, collateral, cash contribution from the owner, current cash flow, owner experience, and so forth, are not mentioned.
After deciding which model to use, an owner must ensure that any designs, names and ideas they plan to use and publish are not currently protected. A search through the database on the U.S. Patent and Trademark Office’s website will let you know if your name or idea is already registered. It’s important to search for the exact name, plus variations of the name including misspellings and similar sounding words or phrases.
In addition, you should do a basic internet search. After verifying that you have not infringed on any current patent and trademarks, be sure to federally register all relevant ideas, names, and designs to ensure that your work is protected.
Deliver on all promises
After a successful campaign to raise capital, a small business owner has continuing obligations to investors. There are numerous horror stories from donation crowdfunding sites like Kickstarter in which entrepreneurs go bankrupt following a successful campaign because they did not plan for the volume they would pre-sell or the additional funds needed to fulfill promises.
There are also commonly legal claims filed against entrepreneurs by investors who did not receive products. Set a realistic monetary goal and plan ahead if you are manufacturing a new product or providing a service. Donation crowdfunding sites serve as facilitators and hold no liability. If you receive the funds; you are on the hook to deliver.
Depending upon your product or service, the money raised may qualify as income or a non-taxable gift. There could also be issues related to sales tax and the issuance of 1099s.
All of these issues should be carefully considered prior to starting any new crowdfunding campaign. While these can be valuable resources of capital, the proper planning, research, and professional guidance will help ensure your great idea enjoys the success it deserves.
Charles Bowen is a business attorney who focuses on commercial, banking and manufacturing law and also offers comprehensive mediation services. He may be contacted at 912.544.2050 or firstname.lastname@example.org