Crowd funding or crowdfunding (alternately crowd
financing, equity crowdfunding, or hyper funding)
describes the collective effort of individuals who network and pool
their money, usually via the
Internet, to support efforts initiated by other people or
organizations.[1][2]
Crowd funding is used in support of a wide variety of activities,
including
disaster relief,
citizen journalism, support of artists by fans, political campaigns,
startup company funding,[3]
movie[4]
or
free software development, inventions development and scientific
research.[5]
Crowd funding can also refer to the funding of a company by selling
small amounts of equity to many investors. This form of crowd funding
has recently received attention from policymakers in the United States
with direct mention in the
JOBS Act; legislation that allows for a wider pool of small
investors with fewer restrictions.[2]
The JOBS Act was signed into law by President Obama on April 5, 2012.
The
U.S. Securities and Exchange Commission has been given approximately
270 days to set forth specific rules and guidelines that enact this
legislation, while also ensuring the protection of investors.[6]
Some rules have already been proposed by the SEC.[7][8]
History
In 1997, fans underwrote an entire U.S. tour for the British rock
group
Marillion, raising $60,000 in donations by means of a fan-based
Internet campaign.[9]
The idea was conceived and managed by fans without any involvement by
the band, although Marillion has since used this method with great
success as a way to fund the recording and marketing of its albums from
2001 to the present.[citation
needed]
Anoraknophobia,[10][11]
Marbles,[12]
and
Happiness Is the Road.[13]
The United States based company
ArtistShare (2000/2001) is documented as being the first
crowdfunding website for music followed later by sites such as
Sellaband (2006),
IndieGoGo (2008),
Spot.Us (2008),
Kickstarter (2009) and
Microventures (2010).
[14][15]
Electric Eel Shock, a Japanese rock band who have toured the world,
became one of the first bands without a previous significant recording
deal to fully embrace crowdfunding. In 2004 as an unsigned band they
raised £10,000 from 100 fans (the Samurai 100) by offering them
guestlist for life.[16]
Two years later they became the fastest band to raise a 50,000 budget
through SellaBand.[17]
They licensed the album internationally including to Universal in their
native Japan.
In the film industry, independent writer/director
Mark Tapio Kines designed a website for his then-unfinished first
feature Foreign Correspondents in 1997. By early 1999, he had
raised more than $125,000 over the Internet from at least 25 fans,
providing him with the funds to complete his film.[18]
Franny Armstrong later created a donation system for her feature
film
Age of Stupid.[19]
Over five years from June 2004 to June 2009 (release date) she raised
£1,500,000.[20]
In December 2004, French entrepreneurs and producers
Benjamin Pommeraud and
Guillaume Colboc launched a public Internet donation campaign
[21]
to fund their short science fiction film, Demain la Veille (Waiting
for Yesterday). Within 3 weeks, they managed to raise $50,000,
allowing them to shoot their film.
Morton Valence are an early example of a relatively obscure band to
independently enter into crowd funding without using a third party
website such as Sellaband.[22]
Crowd funding's earliest known citation[23]
was by Michael Sullivan in fundavlog on August 12, 2006. Nowadays, there
are over 500 crowdfunding platforms all over the world and it has come
to the point where project creators need to do their own due diligence
in order to understand which platform is the best one to use depending
on the type of project that they want to launch.[2]
In 2012, President Barack Obama signed the JOBS (Jumpstart Our
Business Startups) Act, legislation that effectively lifted a
previous ban against public solicitation for private companies raising
funds.[24]
As of August 13, 2012, the Securities Exchange Commission has yet to set
rules in place regarding equity crowdfunding campaigns involving
unaccredited investors for private companies; however, rules are
expected to be set by January 1, 2013. Currently, the JOBS Act allows
accredited investors to invest in equity crowdfunding campaigns.
In 2012, TIME published an article describing and rating the best
crowdfunding platforms in the world.[25]
Related
definitions
There are questions about the legality of taking money from
"investors" without offering any of the security demanded by legitimate
investment schemes. Sites such as
ArtistShare,
Pledgemusic and
Funding4Learning have a failsafe. They hold funds in an
escrow
account.[citation
needed] If the nominated target isn't reached, all
funds are returned to contributors. While sites such as
Indiegogo,
RocketHub and
Sponsume allow projects to keep all the funds raised.[citation
needed]
Investors are given something for their money - so in a legal sense,
they have paid for and received something.[citation
needed] The Tunnel is selling frames of film for
one dollar each. Pioneer One gives you the theme music or a special
edition download.[citation
needed]
Micropatronage is a system in which the public directly
supports the work of others by making donations through the Internet. In
use as early as 2001,[citation
needed] the term was popularized in 2005[citation
needed] by
blogger
Jason Kottke when he quit his day job as a web designer and spent a
year blogging full time, living off the voluntary donations of his
readership. Micropatronage differs from traditional
patronage systems by allowing many "patrons" to donate small
amounts, rather than a small number of patrons making larger
contributions.
Contemporary applications
Crowd funding is being experimented with as a funding mechanism for
creative work such as
blogging
and
journalism,[26]
music,
and
independent film,[27][28]
for funding a
startup company,[29][30][31]
and even for funding public projects.[32]
Community music labels are usually for-profit organizations where "fans
assume the traditional financier role of a record label for artists they
believe in by funding the recording process".[33]
Since pioneering crowd funding in the film industry Spanner films
have published a useful ‘how to’ guide.[34]
Innovative new platforms, such as
RocketHub, have emerged that combine traditional funding for
creative work with branded
crowdsourcing - helping artists and entrepreneurs unite with brands
"without the need for a middle man."[35]
Crowd lending from non-banks is gaining momentum globally as banks
have increased interest rates or pulled back from lending to consumers
and small businesses; however, as of early 2012, the non-bank sector of
crowd lending is yet to be considered a threat to the big consumer
lending businesses of the largest global banks.[36]
Crowd
funding philanthropy
A variety of crowd funding platforms has emerged to allow ordinary
web users to support specific philanthropic projects without the need
for large amounts of money.
Global Giving allows individuals to browse through a selection of
small projects proposed by nonprofit organizations worldwide, donating
funds to projects of their choice. Microcredit crowd funding platforms
such as
Kiva (organization) and
Wokai
facilitate crowd funding of loans managed by microcredit organizations
in developing countries. The US-based nonprofit
Zidisha
offers a new twist on these themes, applying a direct
person-to-person lending model to microcredit lending for low-income
small business owners in developing countries.
Zidisha
borrowers who pass a background check may post microloan applications
directly on the Zidisha website, specifying proposed credit terms and
interest rates. Individual web users in the US and Europe can lend as
little as one US dollar, and Zidisha's crowd funding platform allows
lenders and borrowers to engage in direct dialogue. Repaid principal and
interest is returned to the lenders, who may withdraw the cash or use it
to fund new loans.[37]
Intellectual property exposure
One of the challenges of posting new ideas on crowd funding sites is
there may be little or no
intellectual property (IP) protection provided by the sites
themselves. Once an idea is posted, it can be copied. As Slava Rubin,
founder of IndieGoGo said: “We get asked that all the time, ‘How do you
protect me from someone stealing my idea?’ We’re not liable for any of
that stuff.”[38]
Inventor advocates, such as Simon Brown, founder of the UK-based United
Innovation Association, counsel that ideas can be protected on crowd
funding sites through early filing of
patent applications, use of
copyright and
trademark protection as well as a new form of idea protection
supported by the
World Intellectual Property Organization called
Creative Barcode.[39]
Patent disputes
On September 30, 2011, the crowdfunding site Kickstarter filed a
request for
declaratory judgment against Fan Funded who owns U.S. patent
US 7885887,
"Methods and apparatuses for financing and marketing a creative work".
Brian Camelio, founder of ArtistShare, is the inventor on the
patent. Kickstarter says it believes it is under threat of a patent
infringement lawsuit. Kickstarter has asked that the patent be
invalidated, or, at the very least, that the court find that Kickstarter
is not liable for infringement.[40][41]
In February 2012, Fan Funded responded to Kickstarter's complaint
notably claiming that
patent infringement litigation was never threatened, that
"ArtistShare merely approached KickStarter about licensing their
platform, including patent rights", and that "rather than responding to
ArtistShare's request for a counter-proposal, Kickstarter filed this
lawsuit."[42]
Pros and cons
Proponents of the crowd funding approach argue that it allows good
ideas which do not fit the pattern required by conventional financiers
to break through and attract cash through the
wisdom of the crowd. If it does achieve "traction" in this way, not
only can the enterprise secure seed funding to begin its project, but it
may also secure evidence of backing from potential customers and benefit
from
word of mouth promotion in order to reach the fundraising goal.[2]
Another potential positive effect is the propensity of groups to
"produce an accurate aggregate prediction" about market outcomes as
identified by author
James Surowiecki in his book
The wisdom of crowds, thereby placing financial backing behind
ventures likely to succeed.
Proponents also identify a potential outcome of crowdfunding as an
exponential increase in available
venture capital. One report claims that If every American family
gave one percent of their investable assets to crowdfunding, $300
billion (a 10X increase) would come into venture capital.[43]
Proponents also cite that a benefit for companies receiving crowdfunding
support is that they retain control of their operations, as voting
rights are not conveyed along with ownership when crowdfunding.
While this does not usually apply to artists and charitable
organizations, a disadvantage for business is the requirement to
disclose the idea for which funding is sought in public when it is at a
very early stage. This exposes the promoter of the idea to the risk of
the idea being copied and developed ahead of them by better-financed
competitors.[citation
needed]. For crowdfunding of equity stock
purchases, there is some research in social psychology that indicates
that, like in all investments, people don't always do their due
diligence to determine if it's a sound investment before investing,
which leads to making investments decisions based on emotion rather than
financial logic.[44]
Crowdfunding draws a crowd, investors and other interested observers
who follow the progress, or lack of progress, of a project. Sometimes it
proves easier to raise the money for a project than to make the project
a success. Managing communications with a large number of possibly
disappointed investors and supporters can be a substantial, and
potentially diverting, task.[45]
Legal restrictions
Another significant disadvantage to crowd funding is the possibility
of getting ensnared in various securities laws, since soliciting
investments from the general public is most often illegal unless the
opportunity has been filed with an appropriate securities regulatory
authority, such as the
Securities and Exchange Commission in the U.S., the
Ontario Securities Commission in Ontario, Canada, the
Autorité des marchés financiers in France and Quebec, Canada, or the
Financial Services Authority in the U.K. These regulators can have
different ways of determining what is and what is not a security but a
general rule one can rely on (at least in the U.S.) is the
Howey Test. The Howey Test says that a transaction constitutes an
investment contract (therefore a security) if there is (1) an exchange
of money (2) with an expectation of profits arising (3) from a common
enterprise (4) which depends solely on the efforts of a promoter or
third party. Clearly, under this standard, any crowd sourcing
arrangement in which people are asked to contribute money in exchange
for potential profits based on the work of others would be considered a
security. As such, the applicable investment contract would have to be
registered with a regulatory agency (such as the S.E.C.) unless it
qualified for one of several rule-laden
exemptions (e.g., Regulation A or Rule 506 of
Regulation D of the
Securities Act of 1933, or the California Limited Offering Exemption
- Rule 1001 (also known as S.E.C. Rule 1001)). The penalties for a
securities violation can vary greatly and depend in large part on the
amount of profit obtained by the "promoter," the damage done to the
investors, and whether a violation is a first time offense. However, a
violation may result in both civil and criminal penalties, a return of
any profit made and sometimes a lifetime ban from work in the securities
industry. According to Section 5 of the Securities Act, it is illegal to
sell any security unless such a sale is accompanied or preceded by a
prospectus that meets the requirements of the Securities Act.[46][citation
needed]
Equity
Equity Based Crowdfunding is a mechanism that enables broad groups of
investors to fund startup companies and small businesses in return for
equity. Investors give money to a business and receive ownership of a
small piece of that business (equity and / or debt). If the business
succeeds, then its value goes up – and so does the value of that share
of that business. The converse is also true. Coverage of Equity Based
Crowdfunding indicates that its potential is greatest with Startup
businesses, who are seeking smaller investments to launch and that
additional follow-on funding required for rapid growth may come from
other sources.[47]
United States
History
Summer 2011 Jenny Kassan
[48],
Paul Spinrad
[49]and
Danae Ringelmann of Indiegogo
[50]
met and lobbied CrowdFunding at the Government-Business forum on Small
Business Capital Formation at the SEC meeting
Nov. 18, 2010[51].
[[1]]In
February 2011, Jason Best, Sherwood Neiss, and Zak Cassady-Dorion
Principals of Crowdfund Capital Advisors banded together and formed
Startup Exemption with the goal to lobby Washington, D.C. to update the
U.S. Federal Security Laws and make it legal for entrepreneurs to use
crowdfunding to raise a limited amount of early-stage equity-based
financing. With the assistance of the Small Business and
Entrepreneurship Council (SBEC) they partook in two hearings on Capitol
Hill. Their framework was the basis for the Entrepreneur Access to
Capital Act[52]
introduced by Rep. Patrick McHenry (R-NC) on September 14, 2011.
Crowdfund Capital Advisors formerly known as StartUp Exemption with CEO
Vince Molinari at Gate Technologies and Chairman and founder David Drake
of
The Soho Loft had Congressman Patrick McHenry present March 13-14,
2012 in Los Angeles
[53],
previously having Congressman Patrick McHenry
interviewed and speak
[54]in
NYC Jan 23, 2012
[55]
and subsequently created the CrowdFunding Intermediary Regulatory
Association (CFIRA)
[56]
from the initiation by
The Soho Loft. CFIRA shortly thereafter divided itself into the
Crowd Funding Professional Network and CrowdFund Intermediary Regulatory
Advocates. April 19th, 2012 was their 2nd meeting in New York City
The Soho Loft and the conclusion was to Friday April 20th have their
first meeting with the SEC in Washington, DC
[57].
Legislation
The bill went through a number of amendments and on April 5, 2012
President
Barack Obama signed the
JOBS Act into law.[58]
The legislation mandates that funding portals must register with the SEC
as well as an applicable self-regulatory organization to operate.[59]
The JOBS Act places limits on the value of securities issuer may offer
and individuals can invest through crowdfunding intermediaries. An
issuer may sell up to $1,000,000 of its securities per 12 months, and,
depending upon their net worth and income, investors will be permitted
to invest up to $100,000 in crowdfunding issues per 12 months.[60]
An independent financial statement review by a CPA firm is required for
raises $100,000-500,000 and an independent financial statement audit by
a CPA firm is required for raises over $500,000.[61]
Regulation
The SEC is now drafting regulations to implement the equity and debt
crowdfunding provisions of the bill.[8][62]
In parallel to the SEC regulations, the
Financial Industry Regulatory Authority(FINRA) is creating
additional rules related to member firms engaged in crowdfunding.[59]
Funding Portals
The JOBS Act enables equity based crowdfunding when it is conducted
by a licensed broker-dealer or via a Funding Portal registered with the
SEC.[63]
Many
Crowdfunding Portals have launched to fill this role, and the space
is evolving rapidly. Early portal
Profounder closed before SEC guidelines were released,[64]
and equity portal
Earlyshares acquired charity portal
Helpersunite.[65]
Many portals have also consulted the SEC on its guidelines.[66][citation
needed]. The first portal operating in the U.S. and
geared towards small businesses was founded in 2010 by
Alejandro Cremades and Tanya Prive and is operating under the name
of Rock The Post.[67]
Industry
Associations
A number of US organizations have been founded to provide education
and advocacy related to equity based crowdfunding as enabled by the
JOBS Act. They include:
United Kingdom
The first Financial Services Authority (FSA) regulated crowdfunding
platform launched in the UK was
Abundance Generation it was approved in July 2011 and launched to
the public in the spring of 2012.,[71]
Abundance Generation provides debt finance to UK based renewable
energy developers.
On 6 July 2012,
Seedrs
Limited launched as the first equity crowdfunding platform to have
received regulatory approval anywhere in the world, from the Financial
Services Authority (FSA).[72]
In August 2012
Richard Branson announced his support in the
Telegraph for CrowdFunding, CrowdInvesting and CrowdLending platform
BankToTheFuture.com.
Australia
Crowdfunding as a discrete activity is not prohibited in Australia.[73]
Sources cite that it has been legal in Australia for 7 years.[8]