Crowdfunding Types You Need to Know

Crowdfunding can be a great opportunity for you to gain financial support, resources, guidance, and advice from experts quickly. That way, you have a platform to showcase your new products, services, or ideas to a group of donors and investors who have an interest and stake in your company.

The first decision is to identify which type of crowdfunding (or a mixture of a few) is right for your company:

• Donation-based crowdfunding – Individuals contribute money with no expectation of anything in return (perfect for community projects, charitable causes, medical expenses, and other charitable or individual needs).
• Reward-based crowdfunding – Donors receive a non-financial reward for their donation (popular with startup companies that are willing to offer free products or services to donors). These donors do not obtain any type of ownership in the company and just receive free products or services.
• Equity crowdfunding – Investors receive equity or shares in the business they are investing in through the fundraising efforts (popular for startups looking to raise a large amount of capital). This is a great option for businesses to raise capital without having to meet several strict and rigorous regulations. Yet, it still comes with some compliance issues that we will discuss in more detail below.
• Debt crowdfunding – Donors receive repayment of their original donation plus interest, which is similar to standard debt guidelines. Although this seems like a normal debt process, some companies find this option attractive because the donors and/or investors do not receive ownership benefits in the company.

Adhering to crowdfunding compliance regulations is imperative, especially with equity and debt crowdfunding. Not only do they involve the exchange of securities, non-compliance can lead to substantial fines, prosecution, and even the invalidation of shares. These hefty issues also come with the time and money it takes to legally battle non-compliance matters and the potential damage to your reputation.

Compliance Tips From the SEC

When we advise our own clients on crowdfunding opportunities, we have found that many startups and seasoned businesses are interested in either equity or debt crowdfunding. Although these are two great options to raise capital for a new business venture, these options come with crowdfunding regulations and compliance requirements.

Both equity and debt crowdfunding are forms of what is called “regulation crowdfunding,” which is a federal regulation that permits businesses to sell securities through a crowdfunding venture.

On a federal level, the Securities and Exchange Commission (SEC) is in charge of regulating these types of crowdfunding endeavors. Regulation crowdfunding is exempt from the SEC’s requirement that any issue or subscription of a business’s securities be registered with the SEC. However, there are still strict compliance rules for regulation crowdfunding that are meant to protect both the business and the investors, while also encouraging economic growth.

The SEC’s regulation crowdfunding stipulations are detailed in Title 17, Chapter II, Part 227 and can be quite intimidating to sift through. We have summarized some of the main points here using the SEC’s site for clarity:

• All transactions must take place online through an SEC-registered, third-party intermediary (i.e., a broker-dealer or funding portal, such as GoFundMe, Kickstarter, Indiegogo, etc.).
• Fundraising totals cannot exceed $5 million within a 12-month period.
• The number of non-accredited investors is limited during a 12-month period, and they must abide by strict limitations on how much they can invest, as stipulated by the SEC (accredited investors include banks, savings and loan associations, insurance companies, etc. A detailed list can be found here).
• There are liquidity limitations that include not being able to transfer the interests for an initial period of 12 months.
• Disclosures of information must be filed with the SEC, investors, and the intermediary that is facilitating the transaction.

In addition to the SEC regulation crowdfunding stipulations, it is important to research your state’s tax law implications that may affect your crowdfunding prospects. Critical Connexion works with tax experts who can help you decipher how your specific state deals with the tax implications of crowdfunding.

Are There Benefits to Crowdfunding?

Crowdfunding can be a lucrative way to raise capital for your business venture, and as long as you adhere to the SEC regulations and your own state’s tax implications, you can use crowdfunding to help make your company’s dreams come true. Some benefits we have seen through crowdfunding include:

• Access to capital for startups that may not qualify for traditional bank financing.
• “Free” advertising and marketing in one’s community by building awareness through the early adopters and investors.
• Priceless feedback from experts who are emotionally and financially invested in your new idea.

Is crowdfunding right for you? We have seen quite a bit of success with startups that have used crowdfunding for their new products and services, especially when these new ideas resonate with a broad audience. If you work in a highly-regulated industry or a “niche” business environment, however, you will want to weigh the legal and regulatory implications with the crowdfunding benefits mentioned above.