Crowdfunding

A Guide to Raising Capital on the Internet

Steven Dresner

• Publisher: Wiley
• Year: 2014
• Print ISBN: 9781118492970
• eBook ISBN: 9781118746868
• Edition: 1
• Topic: Business
• Subtopic: Entrepreneurship
• Index: Business

A groundbreaking book on the growing trend of crowdfunding

Crowdfunding has gained considerable traction over the last few years. By combining the Internet/social media with equity-based financing, it is poised to usher in a new asset class that will change how early stage and small business financing transactions are consummated. Author Steven Dresner, Founder and CEO ofDealflow.com, understands the nuances of how crowdfunding can help companies gain much needed access to capital, and now he shares those insights with you.

Engaging and informative, this book will serve the needs of a global audience comprising entrepreneurs, financiers, and other professionals. It skillfully addresses the market dynamics that are catapulting crowdfunding into the mainstream and explores essential issues ranging from planning an online campaign, post-transaction management, and business planning to securities law and tax issues.

• Puts the business of crowdfunding in perspective with a look at the current marketplace, overview of important data, and legitimate concerns
• Examines effective techniques for communicating with the crowd
• Details equity-based financing and other sources such as debt instruments
• Contains contributions from a wide array of individuals involved in the worlds of finance, law and accounting, social media, marketing, as well as DealFlow Media's own staff

Crowdfunding affords-start ups and other smaller businesses better access to capital via the Internet/social media. It also allows an investor of any size to back a business of their choosing. This new book will show you what this process entails and how it can benefit everyone involved.

Part I
The Business of Crowdfunding

Chapter 1
Crowdfunding: A Historical Perspective

Jason Best and Sherwood Neiss

Crowdfund Capital Advisors

Crowdfunding, simply put, is pooling the financial resources of many individuals to convert an idea into a project or business. Instead of relying on a few large donors, it requires many small ones. This chapter steps back in time to understand what happened to this form of financing, why it’s “new all over again,” and why it’s emerging as one of the hottest topics in global business financing. It reviews the risks that led to changes in U.S. financial laws in the early twentieth century and how these laws had the unintended consequence of shutting off capital markets to many startups and small businesses. It discusses how advances in the Internet and technology have allowed us to safely go back to where we started. Today’s crowdfunding enables anyone to use the Internet to gauge the value of people’s ideas and use online reputations and their own judgment and experience to make their own decisions about which ideas have the best chance for success.

Crowdfunding Isn’t New

Crowdfunding is a new way to do something old. It uses the Internet to facilitate capital formation in much the same way that communities financed transactions as far back as 3000 B.C. Prior to the advent of banks and other financial institutions, wealthy families and rulers provided loans to individuals in communities to finance everything from businesses to infrastructure. Financial instruments not unlike simple loan documents used today were created as promissory notes. Interest rates were determined based on how well individuals knew each other and how much capital was needed. Risk was a function of relationship and ability to execute. Default came with a heavy toll.

While difficult to relate the experiences of 5,000 years ago to today, life in the United States in the late nineteenth and early twentieth centuries offer some examples of American institutions and icons that emerged from the crowd. In the 1930s, before the Great Depression, banks existed primarily to finance infrastructure and the activities of governments. This was ushered in by the Industrial Revolution that led to a change in farming techniques. In order to adapt, farmers were forced to take loans for equipment. Other businesses faced similar technology shifts and access to capital was the same challenge.

Building and loan associations were one of the answers to how to provide capital to businesses and individuals. Groups of people deposited their savings into an association. When the association gained enough money, it financed activities for its members, mainly through mortgages. This system helped many working-class people buy homes. Unlike banks, these associations made their investments based primarily on the interests of their members instead of on the promise of the greatest returns and security. Associations, however, tended to serve small groups or communities and didn’t offer many of the services that banks did.

In 1876, crowdfunding was used to finance one of the United States’ most iconic monuments, the Statue of Liberty. The citizens of France paid for the statue, and the citizens of the United States paid for the pedestal. Citizens in both countries held meetings, theater performances, art auctions, prizefights, and rallies to raise money. Frédéric Auguste Bartholdi, the Statue of Liberty’s architect, offered a miniature version of the statue with the name of the buyer engraved on it in exchange for a donation—a “perk” when compared to today’s crowdfunding.

Despite being $250,000 short, newspaper publisher Joseph Pulitzer used The World, a New York City daily newspaper, to mount a fund drive, promising to print the name of each donor. Pulitzer’s plan worked and millions of people around the country began donating whatever they could including a kindergarten class in Iowa that sent $1.35.

Why? Because these people believed in the project and wanted to give back; they wanted to be a part of history and be a part of something bigger than themselves. These are the same reasons people give to crowdfunding today. Times might have changed but core beliefs have not.

Why Crowdfunding Disappeared

In the early 1900s, the main role of investing in startups and small businesses fell into the hands of wealthy families like the Morgans, the Vanderbilts, and the Rockefellers. Starting in 1911, the process of raising capital from the public was enforced by each state under so-called blue sky laws. With these laws, states regulated the offering and sale of stocks to protect the public from fraud. The specific provisions of these laws varied among states, but they all required the registration of all securities offerings and sales, as well as the registration of every stockbroker and brokerage firm. Providing a structure was a benefit; lacking an infrastructure to monitor, police, and hold people accountable opened the doorway to fraud.

In 1915, the Investment Bankers Association told its members that they could ignore blue sky laws by making securities offerings across state lines through the mail. Allowing solicitation via a mechanism as opaque at the mail opened up the floodgates to fraud. Because the markets weren’t regulated at the federal level, shady stockbrokers started to issue stocks in dubious, fictitious, or worthless companies and sell them to people in other states, using the mail as their means of communication.

This ushered in a period replete with snake oil salesmen and grifters moving from one opportunity to the next and debunking Americans out of their savings. During the 1920s leading up to the Great Depression, which began in 1929, the marketplace was full of exuberance. Stock prices kept going up, reinforced by shady brokers. Tempted by promises of riches and easy credit, many investors started to borrow money to buy essentially worthless stocks. Greed drove them to neglect the risks and believe unreliable information about the securities in which they invested.

During the 1920s approximately 20 million large and small shareholders set out to make their fortunes in the stock market. Of the $50 billion in new securities offered during this period, approximately half became worthless as a result of the stock market crash in October 1929.

When the stock market crashed, public confidence in the markets collapsed. Investors large and small, as well as the banks that had loaned to them, lost great sums of money in the ensuing Great Depression. For the economy to recover, the public’s faith in the capital markets needed to be restored, so Congress held hearings to identify the problems and search for solutions.

Congress passed the Securities Act of 1933. This law and the Securities Exchange Act of 1934—which created the U.S. Securities and Exchange Commission (SEC)—were designed to increase public trust in the capital markets by requiring uniform disclosure of information about public securities and establishing rules for honest dealings. The main purposes of these laws can be reduced to two common-sense notions:

1. Companies publicly offering securities for investment must tell the public the truth about their businesses, the securities they’re selling, and the risks involved in investing.
2. People who sell and trade securities—brokers, dealers, and exchanges—must treat investors fairly and honestly, putting investors’ interests first.

Congress established the SEC to enforce the newly passed securities laws, to promote stability in the markets, and, most important, to protect investors. The Securities Exchange Act of 1934 requires that issuing companies register distributions of securities, such as stocks, with the SEC prior to interstate sales of these securities. This way, investors have access to basic financial information about issuing companies and risks involved in investing in the securities in question.

The SEC was founded in an era that was ripe for reform. The 1933 and 1934 laws set the way in which the capital markets would function for the next 50 years. Having a mechanism where information was centrally stored and accessed by the public was required; today, this is facilitated by the Internet.

Regulation D, Sarbanes-Oxley, and Regulatory Reform

From 1933 to 1982, the way business was conducted in the U.S. capital markets stayed relatively unchanged. In 1982, the SEC adopted Regulation D, which established three exemptions from the registration requirements under the Securities Act of 1933. An exemption enables some companies, in certain situations, to issue securities without the requirement to register them with the SEC provided they follow all the rules. Included within Regulation D’s definitions was the notion of an accredited investor. The SEC adopted two definitions of an accredited investor, one based on net worth and the other based on income:

1. Net worth criteria. Under the net worth definition, an accredited investor is someone who, at the time when he purchases a security, has a net worth of $1 million or more, not including the value of his primary residence. (Note that net worth could be the individual’s net worth alone or that of himself and his spouse.)
2. Income criteria. Under the income-based definition, an accredited investor is someone with individual income above $200,000 during the two most recent years or with joint income (with a spouse) above $300,0...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Dedication
• Acknowledgments
• Introduction
• Part I: The Business of Crowdfunding
• Part II: Preparing for Your Crowdfunding campaign
• Part III: Understanding the Framework of Rules and Regulations
• Afterword
• About the Author
• About the Contributors
• Author’s Disclaimer
• Index
• Advertisement
• End User License Agreement