By Aaron Hagar
Vice President, Entrepreneurship and Innovation, WEDC
Crowdfunding is a hot topic in business and technology articles, but it’s important to keep in mind that the concept of crowdfunding for business finance is not entirely new. A mechanism for companies to raise equity through multiple small investments has existed for a long time—it’s called the stock market, and it’s an almost $19 trillion endeavor in the U.S. alone. With the complexity and expense of “going public” presenting a significant barrier to small companies, their ability to raise equity outside of the public markets has been limited to investment from small numbers or wealthy “accredited investors” — but now, the rise of crowdfunding is making it possible for smaller companies to raise capital without going to a small pool of investors or the expense of an initial public offering.
To date, crowdfunding has for the most part been limited to project-based contributions. Donation-based Internet funding campaigns on websites like Indiegogo and Kickstarter have reached more than $4 billion in total pledges, but these campaigns more closely resemble product pre-sales, gifts, public broadcasting pledge drives or bake sales than investment. Businesses can and do use these sites to develop new products such as the Pebble watch and Pono music player, or Wisconsin’s own Fasetto. But though many of the projects seeking support are art, music, or other passion pursuits, and these campaigns are not investment in the traditional sense, since the “investors” don’t receive equity in the company or any financial upside.
But recently, new mechanisms made available by the federal and some state governments are blurring these lines, allowing for true equity investment by unaccredited investors outside of the stock market—also known as regular folks—using the Internet crowdfunding model.
In 2014, Wisconsin became one of the first states to offer intrastate equity crowdfunding, and since then businesses have been able to raise money through Internet crowdfunding sites. The Wisconsin legislation is restricted to intrastate offerings – (Wisconsin companies raising funds from Wisconsin investors), and any fundraising that crosses state borders is regulated at the federal level. Already, there are a number of Internet site operators registered in Wisconsin, including CraftFund, InVestWisconsin, Badger Crowdfunding and MoolaPitch.com. Participation in Wisconsin’s crowdfunding exemption has thus far has largely been limited to breweries and distilleries, though that divide may simply be a function of businesses that are able to build an exciting brand identity and successfully convert initial customers into financial backers.
Since the U.S. Securities and Exchange Commission (SEC) announced new crowdfunding rules in October 2015, companies now also have an avenue to seek investment from individuals outside of their state’s boundaries. The federal guidelines allow for companies to raise up to $1 million in a 12 month period with limits on how much can come from any individual investor based on income. For investors with less than $100,000 in income the maximum amount they can invest in all companies in a year is the greater of either $2000 or 5 percent of income.
Both the state and federal paths have significant reporting and disclosure requirements, but advocates report that these requirements are easily met using modern means of communication. There are also opinions that crowdfunding may potentially complicate subsequent angel or venture capital (VC) efforts. Due to the relative newness of equity crowdfunding both the benefits and complications have yet to be proven.
What we do know is that these new state and federal rules opens another option for smaller companies, for whom listing on a stock exchange may not be feasible, to attract investment. With the help of modern technology, crowdfunding is revolutionizing business finance for both small companies and small investors. Additionally, as the new crowdfunding paths become better known and more widely used, it is quite possible that the option will become better incorporated into a company’s typical fundraising strategy, and that the practices of angel and VC investors will evolve to account for the restrictions and benefits offered by crowdfunding.