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The Crowdfunding Players

In today’s post, I wanted to take some time to clarify who the major players are in equity-based Crowdfunding.  I will start with the three main players – the Crowdfunding platforms, the investors and the entrepreneurs – and then explain the roles of some other players in the industry.

The Entrepreneurs
Over the past few years, it has become increasingly difficult for anyone who wants to start a business to raise money to get started.  Banks are not lending to businesses without at least three years of profit, they do not have connections to investors, they are too small for investment firms like venture capital – there are many reasons why entrepreneurs have trouble, and most of the time, it has little to do with the viability of the idea.

The Crowdfunding exemption will give entrepreneurs access previously unavailable sources of capital, such as from normal, everyday, non-accredited investors.  Entrepreneurs will use Crowdfunding to gain access to this additional capital from investors who were, before Crowdfunding, not able to invest in their businesses.

The Investors
Prior to Crowdfunding, when reaching out to individuals, entrepreneurs could only ask what are called accredited investors, or individuals with a net worth over $1 million, not including their personal residences, or who make over $200,000 per year ($300,000 if including spouse’s income), or someone with whom they had a “substantial pre-existing relationship” with – i.e. friends and family – for money to start their businesses.

Now, with Crowdfunding, entrepreneurs can raise money from anyone, not just accredited investors or friends and family.  That means that millions of people that were not allowed to invest in small, high-growth potential companies just because they were not wealthy enough, can invest in businesses in their local communities or in any business that they find interesting.

Now anyone can be a part of a startup, helping create jobs in their communities and livelihoods for hundreds and thousands of people.  The investors in Crowdfunding businesses can be any normal investor now, not just the wealthy.

For more advice and educational material for investing in Crowdfunding, see my earlier posts in the Crowdfunding Basics category.

The Platforms (Intermediaries)
How do entrepreneurs connect with investors?  That is where the Crowdfunding platforms come in.  In order to be able to solicit their deal to investors in the general public, entrepreneurs are required to go through a registered Crowdfunding platform – not Facebook, not their websites – only through a platform.  The platforms are where investors will create an account, get information about all of the businesses looking to raise money, keep track of their investments and get updates on how their investments are performing.

When an entrepreneur is ready to raise money, they will send their information to the platform.  When an investor is ready to invest, they will be able to look for businesses they like on the platform.  The platform is where entrepreneurs looking to raise money will connect with investors looking to help get them started.

Other Players
You have also seen me refer several times to the SEC and to the JOBS Act.  The JOBS Act was a bill signed into law in April 2012.  It defines very general rules about how Crowdfunding should work – for example, that an entrepreneur can only go through an online platform to raise money, that they are limited to $1 million, the limits that investors have (see “How Much Can I Invest in Crowdfunding?”), and several other general rules.  However, before equity-based Crowdfunding can begin, the SEC will have to take the general rules from the JOBS Act and make more well-defined, specific rules.

The JOBS Act gave the SEC 270 days to make those specific rules, after which point Crowdfunding will officially be legal.  The 270 day deadline falls on January 4, 2013; however, many people are speculating that the SEC, being very busy these days, will miss the deadline by a few weeks or even a few months.  Even if they hit the deadline, the platforms will still need to register with the SEC, which takes up to 45 days, as well as with another regulatory body called a Self-Regulatory Organization (SRO), which could take even longer.  By the time all of this is completed, it is unlikely that anyone will be raising money through equity-based Crowdfunding from the general public until March 2013, at the earliest, and possibly not even until late 2013 or 2014.

Anyone who is considering raising money through equity-based Crowdfunding, please take note of that, as I would hate for you to expect to be able to raise money in January, as some platforms are leading people to believe, when you will likely not be able to until mid to late 2013, at the earliest.

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2 comments on “The Crowdfunding Players

  1. Great post!

    It’s hard to cut through the excitement around the JOBS Act and determine when companies will actually be able to raise money through crowdinvestment platforms … it’s nice to hear an honest evaluation of when that could be.

    Do you know what type of transactional costs the entrepreneur will need to pay to be able to launch a campaign?

    • Phil Shmerling
      October 17, 2012

      Thank you for checking out the post and for your comment! Here is a nice, long-winded answer to your question. I hope it helps!

      There are some transactional costs an entrepreneur will have to think about when considering Crowdfunding. I had planned a post about some of these, but I will go ahead and touch on a few points here. Of course, these costs are based on what we know today, and the SEC could make rules that end up changing, adding to or reducing these costs.

      The first is the cost you will have to pay to the platform when your raise is completed. Most platforms, today, are saying they will charge based on a percentage of the raise. For example, if you raise $100,000 and their fee is 5%, you will pay a $5,000 fee. The SEC may say that they do not want to allow Crowdfunding platforms to charge a fee that is contingent upon successful raises or as a percentage of what an entrepreneur raises, so this could change to a flat fee. Either way, it is a fee to consider.

      That should be the major “transactional” fee, but there are several other up-front fees and expenses you may need to consider. I have read marketing from several platforms that say it is “free” to apply and list on their platform, and entrepreneurs will only have to pay if they have a successful raise. However, they go on to mention that you will have to pay for your own background check, which we know the platforms will be required to perform. Have you ever applied for a job and paid for your own background check? I think saying, “it is free to list, but…,“ is a bit misleading. I would rather hear, and some platforms may say, that they charge an application fee to help cover some of those upfront costs the platforms will face. So you may face upfront fees for either your background check or possibly an application fee.

      You will also have to think about the legal and accounting expenses you will need to prepare for a raise. The accounting fees will depend on how much you raise, as a full audit is required if you want to raise over $500,000. For raises under $100,000, you will need to provide your tax returns (if any), but you will not need an accountant’s signoff. However, you may want to have an accountant take a look anyway to protect yourself from future legal problems if things do not go well (assuming you did not have an accountant help you prepare your tax returns). Between $100,000 and $500,000, your financials must be reviewed by an accountant, which may also set you back a few.

      In saying all of that, if you were trying to raise money, whether from Crowdfunding, VC, angels, seed capital, etc., you would need these legal and accounting services anyway. So these are not necessarily specific to Crowdfunding like the transactional raises and potential application fees, but they are still expenses to consider. Many platforms may also have relationships with accountants and lawyers that may be able to provide discounted services, which is a way to help reduce costs that you would not have access to in other types of raises.

      I hope this answers your question. When the SEC releases their rules, more expenses could pop up, so be sure to do the research as Crowdfunding gets off the ground. Or just ask me again in a few months, and I will be glad to answer!

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This entry was posted on September 23, 2012 by in Crowdfunding Basics, New to Investing and tagged , , , .
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