WHAT IS CROWDFUNDING? (With a glossary of crowdfunding terminology)

WHAT IS CROWDFUNDING? (With a glossary of crowdfunding terminology)

Bruce Bisbey…please follow us at: https://dumbdogproductionsllc.blogspot.com

The practice of funding a project or venture by raising money from a large number of people who each contribute a relatively small amount, typically via the Internet.

Crowdfunding (alternately crowd financing, equity crowdfunding, crowd-sourced fundraising) explains the collective effort of individuals who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations. Crowdfunding is used in support of a wide variety of activities, including disaster relief, citizen journalism, and support of artists by fans, political campaigns, startup company funding, motion picture promotion, free software development, inventions development, scientific research, and civic projects.

How is Crowdfunding Different?

Crowdfunding is essentially the opposite of the mainstream approach to business finance. Traditionally, if you want to raise capital to start a business or launch a new product, you would need to pack up your business plan, market research, and prototypes, and then shop your idea around to a limited pool or wealthy individuals or institutions. These funding sources included banks, angel investors, and venture capital firms, really limiting your options to a few key players.  You can think of this fundraising approach as a funnel, with you and your pitch at the wide end and your audience of investors at the closed end. Fail to point that funnel at the right investor or firm at the right time, and that’s your time and money lost.  

Crowdfunding platforms, on the other hand, turns that funnel on-end. By giving you, the entrepreneur, a single platform to build, showcase, and share your pitch resources, this approach dramatically streamlines the traditional model. Traditionally, you’d spend months sifting through your personal network, vetting potential investors, and spending your own time and money to get in front of them. With crowdfunding, it’s much easier for you to get your opportunity in front of more interested parties and give them more ways to help grow your business, from investing thousands in exchange for equity to contributing $20 in exchange for a first-run product or other reward.

The Benefits of Crowdfunding

From tapping into a wider investor pool to enjoying more flexible fundraising options, there are a number of benefits to crowdfunding over traditional methods. Here are just a few of the many possible advantages, which we’ll cover in greater detail later in this guide:

Reach – By using a crowdfunding platform like Fundable, you have access to thousands of accredited investors who can see, interact with, and share your fundraising campaign.

Presentation – By creating a crowdfunding campaign, you go through the invaluable process of looking at your business from the top level—its history, traction, offerings, addressable market, value proposition, and more—and boiling it down into a polished, easily digestible package.

PR & Marketing – From launch to close, you can share and promote your campaign through social media, email newsletters, and other online marketing tactics. As you and other media outlets cover the progress of your fundraising, you can double down by steering traffic to your website and other company resources.

Validation of Concept – Presenting your concept or business to the masses affords an excellent opportunity to validate and refine your offering. As potential investors begin to express interest and ask questions, you’ll quickly see if there’s something missing that would make them more likely to buy in.

Efficiency – One of the best things about online crowdfunding is its ability to centralize and streamline your fundraising efforts. By building a single, comprehensive profile to which you can funnel all your prospects and potential investors, you eliminate the need to pursue each of them individually. So instead of duplicating efforts by printing documents, compiling binders, and manually updating each one when there’s an update, you can present everything online in a much more accessible format, leaving you with more time to run your business instead of fundraising.

Types of the most common Crowdfunding

Just like there are many different kinds of capital round raises for businesses in all stages of growth, there are a variety of crowdfunding types. Which crowdfunding method you select depends on the type of product or service you offer and your goals for growth. The 3 primary types are donation-based, rewards-based, and equity crowdfunding (this guide will focus mostly on rewards-based and equity).

Donation-Based Crowdfunding

Broadly speaking, you can think of any crowdfunding campaign in which there is no financial return to the investors or contributors as donation-based crowdfunding.  Common donation-based crowdfunding initiatives include fundraising for disaster relief, charities, nonprofits, and medical bills.

Rewards-Based Crowdfunding

Rewards-based crowdfunding involves individuals contributing to your business in exchange for a “reward,” typically a form of the product or service your company offers. Even though this method offers backers a reward, it’s still generally considered a subset of donation-based crowdfunding since there is no financial or equity return. This approach is a popular option here on Fundable, as well other popular crowdfunding platforms like Kickstarter and Indiegogo, because it lets business-owners incentivize their contributor without incurring much extra expense or selling ownership stake. Read more about preparing and launching a successful rewards-based campaign here.

Equity-Based Crowdfunding

Unlike the donation-based and rewards-based methods, equity-based crowdfunding allows contributors to become part-owners of your company by trading capital for equity shares. As equity owners, your contributors receive a financial return on their investment and ultimately receive a share of the profits in the form of a dividend or distribution

Crowdfunding can also refer to the funding of a company by selling small amounts of equity to many investors. This form of crowdfunding has recently received attention from policymakers in the United States with direct mention in the JOBS Act; legislation that allows for a wider pool of small investors with fewer restrictions. While the JOBS Act awaits implementation, hybrid models, such as Mosaic Inc., are using existing securities laws to enable the public in approved states to invest directly in clean energy projects as part of a crowd.

Crowdfunding has its origins in the concept of crowd-sourcing, which is the broader concept of an individual reaching a goal by receiving and leveraging small contributions from many parties. Crowdfunding is the application of this concept to the collection of funds through small contributions from many parties in order to finance a particular project or venture.

Crowdfunding models involve a variety of participants. They include the people or organizations that propose the ideas and/or projects to be funded, and the crowd of people who support the proposals. Crowdfunding is then supported by an organization (the “platform”) which brings together the project initiator and the crowd.

People who choose to support crowdfunding campaigns often have a personal interest in the project or theme and are often made up of friends and family to start with. Equally, they can be completely unrelated people who just want to get involved in a new project or idea. Crowd funders are typically just as interested in soft rewards as they are in making a profit. They may value the feeling of having contributed or the opportunity to access a particular perk or reward. When it involves film financing, this can be receiving movie merchandise, attending film set or red carpet film premieres, meeting celebrities and actors, or even appearing in the movie.

The days of waiting tables in Hollywood with hopes of bumping into some big name producer or actor or director to fund your movie that you happen to have on you are officially over. If The Veronica Mars Movie, a show that hasn’t been on television in a decade, can raise $5.7 million on Kickstarter, you can too. Crowdfunding is an emerging option for filmmakers to raise film funding for films. Crowdfunding sites are an innovative way forward when it comes to modern film financing. In fact, crowdfunding and equity funding are concepts that are appearing all over the place these days, in a wide variety of contexts. Most recently, the “Gosnell Movie” filmmakers have raised $2.3 million for the movie, a crowdfunding website designed specifically for investing in movies.

Glossary of Crowdfunding Terminology

Crowdfunding – A method of raising capital through the collective effort of friends, family, customers, and individual investors.

Accredited investor – An individual whose net worth is greater than $1MM, or whose income exceeds $200k for the past 2 years. Currently the U.S. Securities & Exchange Commission (SEC) mandates that only accredited investors are legally able to invest in private companies.

Blue Sky Laws - State specific regulations in the United States meant to protect investors from fraud. These laws vary from state to state, but in general they require the registration of all securities offerings and sales with each states appropriate regulatory agency. Some SEC registration exemptions, such as Registration A Tier 2 offerings, pre-empt blue sky laws, meaning that if a securities offering adheres to the SECs requirements it does not have to register and comply with different blue sky laws in every state.

Broker-Dealer - Registered professionals, firms, or agencies that buy and sell securities on behalf of clients, including large stock brokerages. Broker-Dealers execute securities sales and purchases on behalf of clients, provide investment advice to customers, supply liquidity through market-making activities, publish investment research, raising capital for companies, and operate market platforms. Broker-Dealers must be registered with the SEC and are closely regulated. Several types of investment crowdfunding and general solicitation activities require that the issuer work with a registered broker-dealer.

Crowdfunding Platform - A website which facilitates crowdfunding by allowing people or companies seeking money to raise it from members of the public. Platforms list different projects, collect and process the payments between those the crowd funders giving money and the crowdfunded receiving it.

Crowdfunding Portal - Similar to a crowdfunding platform, a portal does not handle investments or finances, but merely acts as an intermediary connecting investors with projects and businesses online. The term Crowdfunding Portal is strictly defined by the SEC in the JOBS act.

Crowd-sourcing / Crowd Sourcing - Piecing together skills and tasks performed by many individuals to put together a larger project.

Convertible Note - A hybrid security. It is a short term loan made to a startup which accrues interest and then converts into equity at a pre-determined time or event, usually issued when a company raises its seed investment round, and then converted to equity when it’s next Series A round of investment in which its valuation is better established.

Debt-based crowdfunding - (also known as "peer to peer", "P2P", "marketplace lending", or "crowd lending") arose with the founding of Zopa in the UK in 2005 and in the US in 2006, with the launches of Lending Club and Prosper.com. Borrowers apply online, generally for free, and their application is reviewed and verified by an automated system, which also determines the borrower's credit risk and interest rate. Investors buy securities in a fund which makes the loans to individual borrowers or bundles of borrowers. Investors make money from interest on the unsecured loans; the system operators make money by taking a percentage of the loan and a loan servicing fee.

Donation-based crowdfunding – Any crowdfunding campaign in which there is no financial return to the investors or contributors. Entrepreneurs presell a product or service to launch a business concept without incurring debt or sacrificing equity/shares.

Emerging Growth Company - A company with revenues below one billion dollars per year, as defined by the JOBS act. Companies meeting these requirements may be eligible for certain privileges, like being allowed to use test-the-waters communications with qualified institutional buyers.

Equity-based crowdfunding – Any crowdfunding campaign that allows contributors to become part-owners of your company by trading capital for equity shares. The backer receives shares of a company, usually in its early stages, in exchange for the money pledged.

General Solicitation - The practice advertising to potential investors outside of one’s current network with the intent of fundraising, as is now allowed by the SEC for private issuers under particular registration exemptions enabled in the JOBS act (Title II 506c, Title IV Reg A, and upcoming Title III Reg CF).

Litigation crowdfunding - allows plaintiffs or defendants to reach out to hundreds of their peers simultaneously in a semiprivate and confidential manner to obtain funding, either seeking donations or providing a reward in return for funding. It also allows investors to purchase a stake in a claim they have funded, which may allow them to get back more than their investment if the case succeeds (the reward is based on the compensation received by the litigant at the end of his or her case, known as a contingent fee in the United States, a success fee in the United Kingdom, or a pactum de quota litis in many civil law systems). LexShares is a platform that allows accredited investors to invest in lawsuits.

I.P.O: An Initial Public Offering - The first sale of stock to public investors by a new company or by an existing company in a new product or project.

Investment Crowdfunding - Investing in a company via crowdfunding in exchange for equity ownership, debt payments, a convertible note, or some other financial return.

Issuer - A company that raises money by creating and selling a security to investors.

JOBS Act - The Jump-start Our Business Startups Act, which was signed into law in 2012. The act eases some securities regulations in order to make it easier for businesses to launch, including through crowdfunding.

Peer to Peer (P2P) Lending - A form of debt crowdfunding, peer to peer lending is when individuals or individual companies offer loans to other individuals or companies. There is a fixed rate of return for such loans.

PIPR - Private Issuer Publicly Raising. A company raising money from investors taking advantage of Regulation D Rule 506(c) which allows general solicitation (advertising) to the public.

Primary Market - The first sale of new securities to investors in order to raise investment money for the issuing company. (As opposed to a Secondary Market in which investors buy and sell securities among each other without the issuing company receiving the funds.)

Private Offering - The sale of investment securities by businesses who do not wish to raise funds through public offerings can seek private placement with a small group of investors. Private offerings must adhere to the rules of any one of several SEC registration exemptions.

Real Estate Crowdfunding - Reserved largely for wealthy investors, real estate crowdfunding involves using mainly equity and peer-to-peer lending to finance real estate purchases using multiple investors.

Rewards-based crowdfunding – Any crowdfunding campaign that involves individuals contributing to your business in exchange for a “reward,” typically a form of the product or service your company offers.

Reward - Something given to investors in exchange for their funds while crowdfunding, either the first run of an actual product, or a shirt, sticker, or small object related to the project or company being funded, or even just a “thank you” acknowledgement.

Rewards Crowdfunding - Crowdfunding in which backers receive a reward in exchange for their financial gift. Reward types are often based on the amount given by investors. Some are offered in various forms that the investors can choose from.

ROI - In short, return on investment. The payback earned from investing in something. Examples include financial return through stocks or emotional return through feeling good about giving.

S.E.C.: Securities and Exchange Commission - The part of the United States government that regulates investment and finance, including startups and the various forms of crowdfunding.

Secondary Market - A market on which securities and assets such as stocks are bought and sold between investors. Secondary Markets provide liquidity by allowing investors to exchange their investment for cash. Also called the aftermarket. (As opposed to a Primary Market in which securities and assets are purchased directly from the issuer.)

Securities - Examples of securities include stocks, bonds, and certificates. These serve as financial and/or investment instruments that hold certain values and that can be bought, sold, and exchanged.

Software value token - Another kind of crowdfunding is to raise funds for a project where a digital or software-based value token is offered as a reward to funders which is known as Initial coin offering (abbreviated to ICO). Value tokens are endogenously created by particular open decentralized networks that are used to incentivize client computers of the network to expend scarce computer resources on maintaining the protocol network. These value tokens may or may not exist at the time of the crowd sale, and may require substantial development effort and eventual software release before the token is live and establishes a market value. Although funds may be raised simply for the value token itself, funds raised on block chain-based crowdfunding can also represent equity, bonds, or even "market-maker seats of governance" for the entity being funded.

Startup - A new business, often using a highly scaleable new technology or novel process, and often outside investment funding, to grow quickly.

Testing the Waters - Communicating with potential investors to gauge interest before raising money or formally registering with the SEC.

Venture Capital (VC) - Equity funding in a startup provided by an investment company.

Venture Exchange - A secondary market in which early investors in startups and small businesses could sell their shares, and new investors could buy and trade private stocks. Meant to improve the liquidity for the securities of small companies. There is currently a draft bill in the House of Representatives intended to expand the use of Venture Exchanges in the US.

Sources & Credits: Google, Wikipedia, Pinterest, IMDB, PMI, Forbes, Indiegogo, Investopedia, Fundable, The Movie Fund, Your Money, Financial Times, Screen Magazine, Variety, Film Maker Magazine, Research Gate, Think Adviser, Crowd Expert

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