The term “crowdfunding” has been thrown around a lot over the past several years. But what does “crowdfunding” really mean? And how does crowdfunding, particularly the recent enactment of rules from Title III of the JOBS Act, relate to network marketing?
At its most basic, crowdfunding is the pooling of financial contributions via the internet for a project or enterprise. The ubiquitous nature of the term has led to a great deal of confusion. However, “crowdfunding” is most easily understood as an umbrella term referring to three different models for raising capital: donation-based, rewards-based, and equity-based. Before discussing the challenges more commonly associated with equity-based donations, let’s cover the more commonly known types of crowdfunding.
DONATION AND REWARD-BASED CROWDFUNDING
Donation-based crowdfunding refers to campaigns in which people contribute money towards a cause and receive nothing but a sense of well-being in return. For example, sites like GoFundMe allow individuals or groups to create online profiles, or “campaigns,” in order to raise money for nonprofits, charities, or even individual medical bills. It’s a safe bet that in your perusal of Facebook or another form of social media, you’ve encountered a donation-based crowdfunding campaign asking for donations to put towards the payment of certain expenses (hospital bills, funeral arrangements, etc.). Rewards-based crowdfunding occurs when one makes a contribution in return for future rewards, such as products or services. Found on platforms like Kickstarter or IndieGoGo, campaigns have produced a wide variety of rewards for contributors from t-shirts to artwork.
Through these two models, a widely accessible pathway exists for people, startups and nonprofits to raise capital through the pooling of relatively small contributions. However, the downside is obvious — the notable absence of a contributor’s ability to receive any sort of financial return. Case in point: Oculus Rift. In 2012, Oculus created a Kickstarter campaign in order to raise money for the creation of a VR (virtual reality) headset called the Rift. More than two years, 9,522 donations and $2.4 million in contributions later, Oculus was bought by Facebook for $2 billion. For backers, the resulting ROI from the sale came in the form of a
briefcase of cash free headset. With these two non-financial return models, it’s difficult to encourage people to make a contribution when there’s zero opportunity for financial incentives. Enter equity-based crowdfunding.
Equity-based crowdfunding entails offering investors an equity stake in a company (i.e., some type of “security”). Securities are a financial instrument that provides its holder some type of monetary value i.e. shares of stock. Any offer of securities must be registered with the Security and Exchange Commission (“SEC”) unless the offer meets a particular exemption. Stated another way, securities regulations, promulgated and enforced by the SEC, limit how and to whom a company may offer its equity. Donation and reward-based crowdfunding fall outside the parameters of SEC regulation because of the absence of security offerings.
Without diving too much into the particular complexities of SEC regulations, a company’s act of making a registered offering, or “going public,” is too expensive for smaller companies, especially in the context of entrepreneurs and startup companies. Quite frankly, the exemptions placed upon exempt, non-public offerings are not conducive for small ventures and startup companies looking to raise money. When exemptions did exist, they provided little relief from the financial constraints placed upon small startups in need of capital.
With this in mind, Congress drafted the Jumpstart Our Business Startup Act (“JOBS Act”) in 2012. The aim behind the JOBS Act was simple: encourage funding for small businesses through the reduction of certain securities regulations. As President Obama signed the JOBS Act into law in 2012, he alluded to the affect crowdfunding would play in the enactment of certain facets of the bill. “Startups and small businesses will now have access to a big, new pool of potential investors. Namely, the American people.”
TITLE III OF THE JOBS ACT
Title III is considered the “crowdfunding” title of the JOBS Act and officially went into effect on May 16th of this year. Under Title III, a company has the ability to raise one million a year from any interested person (i.e., an unaccredited investor) without having to register the sale of such securities through the SEC. For a Company to conduct an offering via Title III, it must complete the necessary offering documents and disclose information pertaining to: (1) name, legal status, and physical address; (2) names of directors, officers, and people holding more than 20% share of the company; (3) a description of the business and its financial condition; (4) a description of the stated purpose and intended use for which the proceeds will be used; (5) the target offering amount; (6) the public price of the securities and the method for determining said price; and (7) a description of the ownership and capital structure of the business.
For businesses interested in using this new method of capital fundraising, the campaign has to take place through an intermediary crowdfunding portal (“funding portal”) or a registered broker-dealer. Note that this portal is an equity-based crowdfunding portal, not one of the two non-financial methods of donation and reward-based like Kickstarter or IndieGoGo. A funding portal must register with the SEC and is subject to the SEC’s authority.
Unlike previous law that preceded the enactment of the JOBS Act, Title III allows ANY investor, not just an accredited one, to invest up to certain financial amounts. However, restrictions exist for HOW MUCH one can invest. Investors who make less than $100,000 a year can invest the greater of 5% their annual income OR $2,000. Investors who make greater than $100,000 can invest up to 10% of their annual income AS LONG AS the amount does not exceed $100,000 in a year.
Title III does exclude certain categories of companies from relying on crowdfunding transactions. These categories include, but are not limited to the following: non-U.S. companies, companies that lack a business plan, and companies that failed to comply with annual reporting requirements.
Crowdfunding has revolutionized traditional forms of fundraising efforts and now — thanks to Title III of the JOBS Act — has the chance to do the same for startups interested in small securities offerings. Benefits aside, this less restrictive method of raising capital doesn’t mean it’s the best option, especially in the context of a network marketing company looking for a product/service offering .
In Part Two of this Series, I’ll explore if Title III’s crowdfunding works in step with network marketing, both as a method for raising capital as well as a product/service offering.