Start-Ups

The rise of crowdfunding: 10 things to know

Crowdfunding platforms are changing the way we finance projects and services, but the laws surrounding them are still ambiguous. Here are 10 facts to get you up to speed.

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Crowdfunding is gaining traction as a way to fund business ideas.
 Image: 1000heads/Flickr

Crowdfunding is a tool that allows anyone -- be it startup founders, musicians, artists, students, children, or even someone in a developing country who lacks basic electricity -- to attract a pool of people via the internet to invest in their business idea. A funding target is established, and rewards to backers are offered.

This new type of startup business model has the opportunity to disrupt industries and change the way we determine success and let the best ideas flourish, rather than the best access to capital. It's exciting, because the venture capital model that powers Silicon Valley and the global startup scene is inherently biased based on geography and connections. According to the Small Business Administration, about 600,000 new businesses are started in the US every year. The number of startups funded by VCs? 300. That means 99.95% of entrepreneurs won't get funded.

To affect real change, we have to understand the basics: what defines crowdfunding, how it works best, and how the current laws shape what's possible. We also need to look at the ways the law is changing and what it means for the future of crowdfunding.

Here is a list of the 10 most important things to know about this important new buzzword.

SEE: Photos: Crowdfunded tech projects that are changing the world

1. There are several different types of crowdfunding

Equity crowdfunding - Investors receive a stake in the company with this model. At the moment, equity crowdfunding is the least developed because of regulations about liability of equity.

Donation-based crowdfunding - Backers come together to donate to support a cause, and may receive a thank-you or shout out.

Reward-based crowdfunding - In exchange for a pledge, a backer receives a gift or other reward (like the product when it is released) instead of money or a share in the company.

2. Niche platforms are popping up everywhere

Most have heard of Kickstarter and Indiegogo when someone says "crowdfunding platforms," but in reality, there are many types of crowdfunding platforms, and more are added to the list every day. Here are a few examples:

Renewable energy - Several platforms, including Mosaic, crowdfund solar power and other renewable energy projects in the US and abroad.

Medical services - Watsi is probably the most notable example in health care. The platform connects people with those in need of medical treatment. The lenders are updated on the status of the patient throughout the process.

Artists - Patreon launched in 2013 as a crowdfunding site for indie artists and creators. People who want to get started in music, the arts, media, and television pitch their ideas to the world in short videos.

Investors - AngelList and others connects angel investors with tech startups around the world.

Inventions - Quirky crowdsources for invention ideas. People pitch the ideas and the crowd votes on their favorites. The best ones are manufactured by the company or one of its industry partners such as GE.

3. Crowdfunding is set for a boom

Recent research from TABB Group shows that the crowdfunding market could reach $17 billion globally by 2015, with more than 1,000 funding organizations formed to raise money. The firm said angel investments should grow to between $28 billion and $50 billion by 2015. That's an 88% increase in lending venues around the world. There is a definite void left by traditional vendors, as small business loans from banks have dropped 32% since 2008. This is an opportunity for the crowdfunding market, and TABB research said that if the SEC gets it right, crowdfunding will have a real chance to compete as an alternative option.

4. Equity crowdfunding is limited to accredited investors

In 2012, President Obama passed the Jumpstart our Businesses Startups (JOBS) Act. It set the stage for the public to receive company equity in exchange for funding a business. Until then, the Securities Act of 1933 stated that that entities could not sell securities until the offering was registered with the Security Exchange Commission (SEC) or there was an available exemption from the registration. The crowdfunding exemption introduced by the JOBS Act won't be put in place until the SEC changes its regulations, which is expected to happen in 2014. Legal equity crowdfunding itself has limits. Individuals with an income less than $100,000 can invest up to 5%, and those who make over $100,000 can invest up to 10%.

5. Laws are changing

These updated regulations would be a big step for the world of crowdfunding because lower net worth individuals could invest in these projects. The JOBS Act Titles II and III should be passed by third quarter of this year. These regulations would allow people to invest through registered brokers or lending portals, but there will be limitations on how much money could be invested.

6. Crowdfunding brings more diversity to business

Crowdfunding gives more women and minorities opportunities to see their business ideas succeed. Investors in all industries have become risk-averse. They often rely on networking and precedent to decide who wins in the business world, and that usually leaves women and minorities hanging. According the the Center for Venture Research, in 2012, only 16% of startups pitching to angels were women-led and only 6% were minority-led. Of the 16%, only 25% actually secure funding.

About 42% of Indiegogo's successful campaigns are run by women. The site also promoted International Women's Day very heavily, and co-founder Danae Ringelmann is trying to make sure women's success in business one of her biggest platforms. Abroad, female entrepreneurs who would never get the chance to promote their business are now being given the opportunity through microlending and crowdfunding platforms.

7. Crowdfunding's big promise to democratize finance

It's the reason Danae Ringelmann started Indiegogo: to democratize finance. Crowdfunding is reshaping the way we invest in businesses, and reorganizing the way we see businesses succeed. Up until now, relationships between angel investors, banks, and startup founders determined which ideas succeeded in the corporate world. With crowdfunding, this is turned upside down, and the public decides when and which ideas succeed based instead on their merit.

8. Crowdfunding promotes globalization

Because crowdfunding platforms allow people from anywhere in the world to start a campaign, it opens up a whole new realm of possibilities for global businesses. Entrepreneurs in developing countries, in particular, who would never have otherwise gotten the chance to propose a business or market a product (especially to people in the Western world), are now on a more level playing field. In addition, crowdfunding platforms for civic projects, environmental projects, and social justice issues provide an opportunity for people to fund projects that can truly have an impact on the world, like bringing clean water, helping start local textile businesses and restaurants, and promoting equal opportunities for all.

9. Microfinancing is not the same as crowdfunding

Microfinancing and microlending are both sometimes considered crowdfunding, but they are quite different. Backers or loaners are paid back over a period of time determined by them and the borrower. The most famous example of microfinancing is Kiva, which matches lenders and borrowers from all over the world and has an exceptionally high payback rate. Another peer-to-peer lending site is Zidisha, which offers a more direct connection and removes the middle man, which are the microfinance institutions (MFIs).

10. Crowdfunding helps promote the triple bottom line

You may have heard that phrase before, and it refers to the triple bottom line of sustainability in business operations -- that is, people, profits, and the planet. The phrase was coined by John Elkington in 1997 in his book, Cannibals with Forks: the Triple Bottom Line of 21st Century Business. The basic concept is the company's responsibilities lie with its stakeholders rather than its shareholders. That means anyone who has an interest or is somehow impacted by the actions of the company.

The triple bottom line has been adopted recently by for-profits, non-profits, and government agencies to show the company has a broader spectrum of determining success. This idea is also very similar to the standards of benefit corporations, who promote business as a power for good.

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About

Lyndsey Gilpin is a Staff Writer for TechRepublic. She covers sustainability, tech leadership, 3D printing, and social entrepreneurship. She's co-author of the upcoming book, Follow the Geeks.

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