Crowding into the Board Room: A new way to invest

Crowdfunding, which uses the Internet to generate small contributions of funding from a large number of people, has been getting a lot of attention lately among entrepreneurs.

Crowdfunding primarily has been used to help raise money to support social causes and to help fund struggling artists.  The money received from crowdfunding has to be considered a contribution or a donation.  In most cases, something nominal is usually offered in return for financial support, such as a free download from a musician.

Historically, because of securities laws, small businesses have been unable to use crowdfunding. Until recently, entrepreneurs had only been able to seek funding from a limited number of people who meet specific income and wealth criteria.

A few creative entrepreneurs have used a loophole in the rules to raise money through crowdfunding.  Rather than treat money raised through a crowdfunding campaign as investments, they offer people something of value in return.  For example, a person opening a new brewpub may get people to “donate” to support the start-up by offering free admission to a special opening night event.  The contributions would be motivated by the desire of local beer enthusiasts to support a new local brewery.  The most commonly used websites that promote traditional crowdfunding are Kickstarter and IndieGoGo.

One instantly legendary crowdfunding campaign was implemented by Eric Migicovsky.  He was raising money for his new wrist watch, called Pebble, which pairs with smartphones via Bluetooth.  Contributors were promised they would get preference to buy a Pebble when the watches were introduced to the market.  Although his initial goal was to raise $100,000, Migicovsky was able to raise over $10 million to help launch Pebble.

The recently enacted Jumpstart Our Business Startups (JOBS) Act of 2012 significantly expands the use of crowdfunding for entrepreneurs.  Under the provisions of this bill, those who provide funding through crowdfunding can now become equity investors with ownership in the business.  The JOBS Act opens up the funding of start-ups to allow almost anyone to invest in entrepreneurial ventures.  Several efforts to create crowdfunding platforms under the JOBS Act are being developed, including one in Nashville called InCrowd Capital, being led by Phil Shmerling.

Attracting investors through crowdfunding requires a different approach than when pursuing funding from angels and venture capitalists, who tend to invest more in the entrepreneurs leading the team than in their ideas.

Crowdfunding investors, on the other hand, are attracted to compelling stories and business ideas they can see themselves using.  What led to the success of the Pebble crowdfunding campaign was that people were excited about a completely new technology that they wanted to be the first to own.  Not every product can create that kind of passion and excitement.

The JOBS Act certainly broadens the pool of people who can invest in small businesses and offers an exciting new avenue for raising money for start-ups.

However, using crowdfunding also may make the entrepreneur’s work more challenging.  If adding just one new partner increases the complexity of running a business, imagine what a crowd of partners can do to complicate an entrepreneur’s life!