Transitioning from Kickstarting to Company Starting
The differences between contribution crowdfunding and equity funding
Sites like Kickstarter and Indiegogo have been enormously successful in popularizing the new trend in fundraising, crowdfunding. As of the writing of this post, Kickstarter boasts nearly 11 million pledges on over 100,000 different projects. For those looking to create an independent film, theater production, video game, or other creative project, sites like this have opened up new opportunities for reaching out to the public to raise money.
Many of these sites operate on a contribution crowdfunding model in order to avoid the necessity of dealing with securities regulation issues. However, new rules are going into effect on Sept. 23 that open the door to a different type of funding for these projects. This alternate method, which uses a new securities law exemption, allows artists and creators to use the power and reach of the Internet to raise money for their company as a whole, rather than for a specific project.
The Kickstarter “contribution” crowdfunding model
The method of crowdfunding currently used by sites like Kickstarter and Indiegogo is known as contribution crowdfunding. Money is raised when a creator advertises a specific project that they wish to produce. Backers then pledge money in return for the promise of receiving some item or reward upon completion of the project. This could be a copy of a videogame, a movie, or some other tangible item. These pledges are usually organized into different tiers, with each higher tier of funding getting a better reward in exchange. For example, some high tier rewards include being in the cast of a movie or lunch with the project creators.
Traditional equity funding methods
In contrast to the contribution model, an equity funding model raises money by selling equity shares in a project or company. There is no expectation of a product reward; the part ownership of the new project and potential growth of the investment is the reward under this model. Typically, raising money in this way involves strict federal and state securities laws. These laws require expensive and time-consuming registration process, making them difficult for new businesses to take advantage of.
A popular way around this registration requirement that many businesses rely on is known as a Rule 506 exemption. This exemption allows an entrepreneur to raise an unlimited amount of money without registering the securities, as long as shares are only sold to a specific class of investor and the opportunity is not generally advertised to the public. There has to be a pre-existing relationship between the business owner and the investors.
Fundraising under the newly passed “general solicitation” rules
New rules, mandated by the JOBS Act and set to go effective on Sept. 23, now allow these equity investment opportunities to be advertised to the public. Called the Rule 506(c) exemption, it permits the use of the Internet, social media, and other mass media advertising to get the word out on new projects looking for funding. As long as the investors meet the net worth or income requirements, the legal hoops to jump through are fewer than they would be for a registered investment offering. With a greater pool of potential investors found through the power of general solicitation and advertising, getting the necessary funding for a creative project could be easier than ever.
Before you start advertising your investment opportunity
Even though the regulations are less stringent under the new Rule 506(c) exemption, there are still very specific filing requirements with the SEC. The penalties for not filing these properly can be quite harsh, and prevent future offerings under the exemption. An attorney who has experience with raising funds under this exemption can help.