Crowdfunding is the collection of money or finance from any number of backers—the "crowd"—to fund an initiative and usually occurs on Internet platforms often called Funding Portals.
Crowdfunding models involve a variety of participants. They include the people or organizations that propose the ideas and/or projects to be funded (“promoter”, “sponsor” “creator” or “issuer”), and the crowd of people who support the proposals(“supporters”, “investors” or “the crowd”. Crowdfunding Portal is the internet website on which a sponsor or the Portal itself has an online presence list the offering in order to bring together the project promoter and the crowd.
The initiative could be to benefit a nonprofit (e.g. to raise funds for a school or social service organization), political (to support a candidate or political party), charitable (e.g. emergency funds for an ill person or to fund a critical operation), commercial (e.g. to create and sell a new product) or a financing campaign for a note or real estate project or even a startup company.
Credit-based crowdfunding is the collective effort of individuals to support efforts initiated by other people or organizations through the provision of finance in the form of credit or a loan. Equity-based crowdfunding is the same as credit-based, except the security issued is in the form of equity (i.e. stock) or ownership in the enterprise.
Certainly a project or investment could contain a combination of both debt and equity. For our purposes, we will lump both credit and equity-based crowdfunding under the generic title of equity-based crowdfunding, which is the focus of this book.
Traditional Finance Groups will be Disrupted
Clayton Christensen, best selling author and professor of business at Harvard, defines the concept of “disruptive” innovation as one that expands participation in a market by lowering the cost to participate in that market. Crowdfunding is disruptive to the Angel investing and Hard Money lending industry; a cottage industry ripe for change and a new found efficiency.
An Angel Investor or Angel is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. A small but increasing number of Angel investors organize themselves into Angel groups or Angel networks to share research and pool their investment capital, as well as to provide advice to their portfolio companies.
The old Angel networks are being disrupted with the new crowdfunding model. Angel investing is inefficient. It rewards or benefits established players. Angel investments have historically been conducted through personal networks and this will shift as the US Securities and Exchange Commission (SEC) continues to lift the ban of general solicitation. The typical Angel process includes lots of meetings and introductions without a central location for buyers and sellers to come together.
Equity crowdfunding platforms streamline the current offline process of raising funds where entrepreneurs might spend months working their online and off-line traditional social and business networks, researching which investors may be a fit, and spending countless amounts of time, money, and effort to just get in front of them. To date, sourcing of investment capital has been very difficult in part because of the historical ban on general solicitation.
Online crowdfunding platforms are making a big push to bring the stealth world of seed stage investing out into the public and into the sunlight for all to see and potentially participate in, depending on their interest. This disruption will result in more information and more choice and will consequently benefit smart investors and make fundraising more efficient for entrepreneurs.
Crowdfunding allows more businesses a larger public platform than they have ever had access to, in order to solicit investment. It will also provide more investors access to opportunities across industries and geographies. It will provide better access and deal flow for the vast majority of the Angel investors who have yet to build their name in their industry. By creating a simple and open marketplace for early stage funding, crowdfunding attracts entrepreneurs who would rather focus on growing their business than on meeting and greeting at networking events.
What changed to create this opportunity?
The basic rule of securities law is that if you want to sell securities, you need to register the offering with the SEC. That is much more involved than it sounds and is totally impractical for the vast majority of companies that are raising money. It can be expensive, both in terms of time, money and management focus.
Up until recently, the world of investing in private companies has only been available to the top 2% of the U.S. population. Now it is time for the other 98% of the population to meaningfully participate like never before. Thanks to the power of the Internet and the easing of regulatory restrictions, here come the 98%, ready or not.
Every day on the Internet businesses and not just products are bought and sold. On Craigslist for instance, it is possible to buy retail businesses with hundreds of thousands of dollars trading hands. Yet as large as these type of transaction are, they are governed by a fraction of the rules for a $100.00 investment in a publicly traded company.
This illustrates a fundamental contradiction of our securities laws and policies impeding capital formation. Buying an entire business requires much more due diligence on the part of the purchaser than investing in a portion of the business. Yet investors buying the smallest portions of the smallest business face more "protections" than if they pay thousands more for a business outright. This paradox and associated burdensome regulatory framework harms the wellbeing of both small investors and small entrepreneurs.
The SEC has created a number of exemptions from registering a stock offering. More such exemptions were ordered to be implemented by the SEC in the spring of 2012 when President Obama signed into law the JOBS Act in an effort to foster entrepreneurship and drive job growth.
Because the SEC took over three years to implement rules governing raising money from non-accredited investors, the State of Texas and other states have proposed regulations to allow various kinds of crowdfunding on an intrastate basis (i.e., where both the issuer of the securities and each investor are residents of the same state).
This kind of crowdfunding (generally called “Intrastate Crowdfunding”) takes advantage of an exemption in federal securities laws that exempts from the coverage of federal law, securities offerings that are entirely between an issuer and investors who are resident in the same state.
Entrepreneurs have the opportunity to Crowdfund Texas projects using Texas investors, without burdensome regulatory or registration requirements. There are a number of other states that have similar intrastate exemptions.