Crowdfunding has become the new frontier for adventurous entrepreneurs looking to finance their budding businesses.
It allows them to raise up to $1 million a year through small-dollar amounts from as many as 2,000 investors through the Internet or social media.
Some say it could be a financing model that sets off a wave of innovation across the country, moving ideas from paper to market at an unprecedented rate.
But entrepreneurs should proceed with caution, because crowdfunding still is the Wild West of financing and it’s dangerous territory, said attorney Michele Fagin, with the Colorado Springs firm Sparks Willson Borges Brandt & Johnson.
One thing is certain: Crowdfunding is the most talked-about, anticipated section of the recently approved 2012 Jumpstart Our Business Startups Act, which lawmakers are hoping will help revive the stagnant economy.
If early projections are right, crowdfunding could produce up to $4 billion in investments during the next three years for early-stage companies, said Monisha Merchant, senior advisor for business affairs to Sen. Michael Bennet (D-Colo.), who sponsored the legislation. The Securities and Exchange Commission is expected to hammer out details of the new financing mechanism and release crowdfunding rules and guidelines in early 2013.
After the rules are unveiled, there could be a swift takeoff of small businesses using crowdfunding to get financed. Already, 26 crowdfunding websites have been accredited by Crowdsourcing.org, a professional association that tracks crowdfunding trends and best practices.
“What I am most excited about is having easier access to money,” said Paul Lizer, founder and CEO of Colorado-Springs-based Devium.
Lizer put his idea, a smartphone car stereo, on Kickstarter.com and raised $74,000.
“What is really important at first is validation,” he said. “Using crowdfunding, you find out there are people out there who think you have a good idea.”
The new crowdfunding
Wildly successful in Great Britain, crowdfunding only now is catching on in the U.S. with websites like Kickstarter.com and Indiegogo.com, where entrepreneurs have found that their good ideas can entice people to help launch new products.
But there are differences between the existing U.S. crowdfunding platforms and the ones that will be created under the JOBS Act, Merchant said.
Current crowdfunding platforms are not regulated by the SEC. People contribute money to a project, relying on good faith that they’ll receive their promised reward, which is sometimes the product.
In the case of local moviemakers Nancy Theken and Pete Schuermann, who recently raised $70,000 on Kickstarter.com, contributors to their Creep! movie received autographed posters and behind-the-scenes footage.
Those who contributed $250 to Lizer’s project will get the smartphone car stereo when it’s manufactured in late September or early October.
Under the JOBS crowdfunding model, contributors to a business become investors, meaning they are shareholders, and product no longer can serve as payment.
“With this legislation, it allows you to contribute and invest, raise money for entrepreneurs and in exchange, you will be given equity,” Merchant said.
That notion is a frightening prospect, Fagin said.
Imagine, she said, having 120 investor grandmothers who are not accredited and have never invested before, demanding daily updates from startup CEOs about their $200 investment. Worse, she said, those less-savvy investors may feel hoodwinked if the business flops, which could lead to personal liability lawsuits against the startup’s founders, she said.
Companies conducting a securities offering must disclose all information about the company, its principals and the investment opportunity — including the investment’s risks. The JOBS Act allows crowdfunding investors to sue the startup for misstatements or omission of information to investors, Fagin said.
In Colorado Springs, where finding risk capital investors can be difficult, there is great interest among entrepreneurs in the crowdfunding model. About 125 people attended a crowdfunding forum Aug. 1 in Centennial Hall hosted by Bennet’s office, Epicentral and SpringsStartup.com.
Fagin, who joined a panel of bankers, entrepreneurs and investors, said she hated to be the wet blanket on the issue. But she warned that accredited angel investors, those who typically have $1 million in net worth or $200,000 in annual income, could be reluctant to co-mingle their money with small, inexperienced investors; or angel investors just won’t want to deal with a company that has hundreds of shareholders. And that, she said, could limit a startup’s prospects.
“Dealing with so many investors will be very difficult,” she said.
This week, Lizer is building 10 pre-production Devium Dash car stereos to test before manufacturing the first round of products.
He came up with the idea of smart phone car stereo in 2010 as he drove away from an electronics store after buying a car stereo that was supposed to interface with his smartphone. The music kept cutting in and out, and he took the device back.
He bought some wood and a car stereo, took it apart and built his own car stereo. His smartphone car stereo has a face plate that can be switched out depending on the phone. He expects the Devium Dash to retail for $400.
Lizer, who still works full time as a systems engineer, might not have pursued making the Devium Dash if not for Kickstarter.com and crowdfunding, which gave him the cash to make the models and got him some national media attention. If this new crowdfunding model under the JOBS Act had existed, he would have tried it, he said.
“There are risks involved,” Lizer said. “But when aren’t there risks involved?”
• Limits securities sales that are part of crowdfunding transactions to $1 million during a 12-month period.
• Caps securities sales during a 12-month period to $2,000 or 5 percent of income for investors whose annual income or net worth is less than $100,000 and 10 percent, not to exceed $100,000, for investors whose net worth is greater than $100,000.
• Allows companies to solicit investments without registering with the Securities Exchange Commission.
Send comment about crowdfunding rules to www.sec.gov/spotlight/jobsactcomments.shtml