Crowdfunding: New Source of Financing for Entrepreneurs
Financing is an ongoing concern for many new and existing businesses. As the availability of bank loans and other traditional financing sources has become scarcer in recent years, entrepreneurs have been searching for new ways to finance their ventures. One of the newer sources is crowdfunding, also known as crowd financing.
Crowdfunding is a group of people who were recruited, usually by social media, to pool their money to finance a new business, new product or other efforts initiated by a business or other organization. Crowdfunding is not limited to businesses. For the endeavor being funded, it spreads the risk across many investors and creates a group of supporters.
The large number of backers makes crowdfunding different from angel investing or venture capital financing. The business is not obligated to one or a few investors who may want some control of the project or business being supported. Some of the larger crowdfunding sites in operation are Wefunder, RockthePost and Kickstarter.
Jim Trutko of Trutko Analytics in Rocky River sees two uses for crowdfunding. This financing tool can be used for civic, social or political causes. It is also can be used to fund new trendy products. “It is a good way to get a leg up on selling a product. Crowdfunding is an applied marketing test.”
Currently, organizations using crowdfunding to finance their ventures are not allowed to offer equity positions to investors. At a recent Small Business Administration conference, an inventor of a new smart phone application discussed how offering a prototype of his product helped attract more funding than he needed in just a few hours. At the same conference, a restaurant owner offered a free meal at his restaurant to anyone investing $100 or more. The key is to find an attractive incentive related to the product or business to entice potential investors.
Impact of JOBS Act
The problems associated with not being able to offer equity to investors may be going away soon. The Jumpstart Our Business Startups Act or JOBS Act as it is more commonly known was passed by Congress and signed by President Obama in April 2012. Its purpose is to relax securities laws to make it easier for smaller businesses to obtain funding. Many believe the law will open the door for crowdfunding investors to acquire shares. The Securities and Exchange Commission has not yet determined the details of the law or how it will be applied to crowdfunding.
If implemented in its current form, the JOBS Act would enable organizations to raise up to $1 million without having to go through the more complex process of a public stock offering. However, the Act would apply only to C Corporations that want to use crowdfunding. S Corporations - a popular form of small business ownership - are currently limited to 100 shareholders, severely curtailing not only the number of investors but also the amount raised.
Role of Social Media
Most of the organizations successfully using crowdfunding have created short video presentations of their propositions to post on the crowdfunding site. The site is monitored and may be changed based on the feedback received by those who visit the site. Organizations using crowdfunding also need to be prepared to answer questions posed by potential investors such as where, when, and how funds will be used.
Prospective investors are drawn to an organization’s crowdfunding site in several ways. First, there is a group of investors who regularly visit crowdfunding sites. Second, other social media are used to drive potential backers to the site. For example, if an organization has fans on Facebook, these fans are a good pool of potential investors and can be directed to the crowdfunding site through the Facebook account or the organization’s web site.
Trutko also noted that not all crowdfunders are alike. “Each site is different. They are aimed at different markets to raise money for different purposes and have different fees and other services.”
As social media develop and government continues to change the rules about how it can be used, crowdfunding appears to be a very attractive source of funding for many entrepreneurs and other organizations.
Dr. Perry Haan is Professor of Marketing and Entrepreneurship, and former Dean of the Business School at Tiffin University. Haan resides in Rocky River and can be reached at 419-618-2867 or firstname.lastname@example.org.