Crowdfunding: a New Frontier for Investors
Crowdfunding for businesses is a new opportunity, but is it a safe place to put your investment dollars?
In 2012, director Steve Taylor embarked on a Kickstarter project just short of impossible: His goal was to raise $125,000 in 30 days after financial backers pulled funding for his movie “Blue Like Jazz,” an adaptation of Donald Miller’s best-selling memoir.
With the help of two fans, Taylor’s campaign blitz succeeded big – as in history-making big. It netted $346,000, a record fundraise for any film project on a crowdfunding platform. And as a promised perk, Taylor made thank-you phone calls to every person who pledged. All 3,500 of them.
Now, with the advent of investor-based crowdfunding, there’s a better way to thank those who pony up dough: by offering them a piece of the financial action. Would Taylor consider it for a future project? “I’d do it in a heartbeat if it could retain the elegance and integrity of Kickstarter,” he says. “But it needs an ingredient the movie business doesn’t understand: transparent accounting.”
Taylor has a point. Since President Barack Obama signed Jumpstart Our Business Startups (the JOBS Act) in 2012, it paved the way for small businesses and startups to raise capital from just about anyone, through the Internet and social networking sites. Yet some experts have urged caution as equity-based crowdfunding gathers steam.
“Like all private investments, these are high-risk,” adds Rory Eakin, co-founder and chief operating officer of CircleUp, a leading equity crowdfunding marketplace that teams up investors with consumer and retail companies. For as little as $1,000, an investor can get a piece of the pie – or scoop of the ice cream, as one of the companies on CircleUp is Alchemy Creamery, a business that makes dairy-free frozen desserts.
An early equity-based investment could result in a big return. But as Eakin acknowledges of crowdfunded hopefuls, “Many of the companies are very early stage and could end up not being successful.” To improve the odds for investors, CircleUp is picky about which companies can raise capital through its site. It has accepted only around 100 of the more than 5,000 that have applied since 2012.
Until now, equity and debt crowdfunding was available only to accredited investors – those the Securities and Exchange Commission defines as having at least $1 million in assets (excluding a main residence) or annual income greater than $200,000 in each of the past two years. But in late March, the SEC adopted what it calls Regulation A+, meaning non-accredited investors can now join the fray.
“The potential upside for investors is that they will be able to review a large number of alternative investments through crowdfunding portals,” says Jacqueline M. Benson, partner at Moye White LLP, a law firm in Denver. “The major concern about crowdfunding is that unsophisticated, unaccredited investors may not understand the true risk of investing in early-stage companies. Not to be all Debbie Downer about early-stage investments, but most early-stage companies do not achieve the level of success that they anticipate on the timeline they estimate.”
Nor will the companies hoping to attract money necessarily have it easy. “The SEC must have graded itself on a very generous curve, because once the cost and time involved are considered, Regulation A+ is more like a B-,” says Jeffrey A. Kelley, senior vice president of Equity Institutional, based in Westlake, Ohio. “The cost of completing the necessary documents has been estimated to be about $100,000.” By the way, that doesn’t include accounting fees to meet reporting requirements, state regulatory fees or costs to promote the crowdfunding opportunity.
Will entrepreneurs want to give crowdfunding a second thought, then? “As someone who has founded a startup, it has become clear to me that all money is not created equal,” says Taylor McPartland, co-founder of CrowdfundX, a Los Angeles-based crowdfunding agency that works with top brands and celebrities. “I would rather give more equity to one or two investors who were very strategic and provided me with insights and introductions than several hundred investors who want their money back if the company doesn’t turn into the next Snapchat.”
“Entrepreneurs funded by lots of smaller investors receive less oversight, and receive less valuable guidance, than those backed by a few larger investors,” adds Clifford Holekamp, senior lecturer in entrepreneurship and director of the entrepreneurship platform at Washington University in St. Louis’ Olin Business School. “Founders might operate their businesses with less discipline when their funders are less engaged and more distant.”
That established, companies that jump trough all the hoops – and attract smart investors – will stick out from the crowdfunding crowd as much as any clever Kickstarter campaign. (Taylor gave his effort urgency when he dubbed it “Save ‘Blue Like Jazz.’”)
“Poorly managed firms and downright charlatans will come and go, but that doesn’t mean crowdfunding is a bad idea,” says Kim Kaselionis, founder and managing partner at Breakaway Funding LLC in Sausalito, California. “A good rule of thumb is to learn the rules of engagement and build an understanding of the pros and cons as well as the pitfalls of the marketplace – and not to fall for the hype some firms will subject you to.”
In other words, “Don’t invest your life savings,” Chris Tsai, CEO of Celery, a key player in the rewards-based crowdfunding realm. “Start small, and get to know the space. Choose projects that are transparent, ideally with a good track record of delivering on previous promises.”
Whether investors strike it rich or strike out, at least the crowdfunding sector itself appears headed for success. McPartland points to a March report by Massolution that shows that more than 1,200 active crowdfunding platforms raised a total of $16.2 billion in 2014. That’s a 167 percent jump from the $6.1 billion raised in 2013.
Yet the monetary possibilities only tell part of the story. “The real reward for crowdfunding investors isn’t financial,” Holekamp says. “It’s the opportunity to participate. Helping an entrepreneur achieve their dreams, and being a part of a company that changes its industry – or maybe even the world – is exciting and personally rewarding. Everyone should have the freedom to make a difference with their dollars.”