I am still asked regularly about what crowdfunding is, whether it is legal, regulated and risky. Here is the Quick Guide to help you decide if it’s right for your startup business.
What is it and how does it work?
‘Crowdfunding’ is an increasingly popular way to raise money for innovative projects, to supporting start-ups and specific business ideas using the internet and social media.
The projects are promoted through crowd funding websites that describe the objectives and funding targets of the project. It may involve millions of people investing as little as $1 to fund the development of goods or services for a project.
Project sponsors, contributors or people who pledge funds typically receive some type of ‘reward’ in return for their funds. In some cases, the ‘reward’ expected may be of minor value (i.e. discounts on products/services, priority access to first product etc.) and is merely incidental rather than the purpose of the contribution. In other cases, you may give a shareholding in your business which becomes a more complicated type of equity fundraising and may trigger regulatory constraints.
Is Crowdfunding regulated?
It is not yet regulated in Australia, as it is in other countries, but it is not prohibited either. We are a bit behind the UK, US, Canada, France, Italy and the New Zealand who have all redrafted their fund raising legislation to allow crowdfunding to flourish.
So, depending in the type of funding arrangement, it could trigger financial product advertising, publicity and investment regulations as well as requiring a disclosure document. In these instances, it’s up to the operators of the crowd funding sites and people using those sites, to comply with the legal obligations.
What are the Pros and Cons?
Pros: The benefits are:
- Low reporting requirements. There are very few regulations regarding crowdfunding so reporting requirements are minimal and limited to ensuring your investors are kept up-to-date;
- Low compliance. As this type of funding is one of the rare unregulated funding sources, compliance is minimal.
- Very little funding on the part of the Investor. Many businesses would otherwise have difficulty raising funding through the more traditional means of banks and other similar investment vehicles who would consider their start-ups too risky or too small. This is a great way to find funding and be able to dictate some of the terms.
Cons: As with anything, particularly unregulated fundraising, there are risks. Here are the main ones and how to try to avoid them:
1. Risk of fraud of Project Creators. Operators can help avoid this by doing background and credentials checks on project creators
2. Risk of non-funding. There is a risk that projects are not funded completely and the project sponsors resultingly don’t received the promised rewards. To help avoid this, website operators can check viability of the project before it is posted. The reality however, is that most website operators will not take on this responsibility and/or don’t have the time.
3. Risk of bankruptcy or fraud of Website Operator. Money may be misappropriated where it is collected and before it is passed on to the project creator. To help avoid this, you can require the website operator to manage all funds in a trust account separate from their own assets.
So how do you get started?
1. Plan your project: Work out how much money you will need, do a detailed project budget with a realistic number that provides for a contingency amount. A good crowdfunding project management guide can be found at Rockethub.
2. Determine the ‘Reward’: Work out what you are ready to give in return for funding to those who are supporting your project.
3. Find a reputable crowdfunding site: There are already a range of successful crowdfunding platforms available in Australia, such as Pozible. OurCrowd, indiegogo, Kickstarter, among others, offering yet another source of funding to get your startup going.
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And finally, check your funding website is reputable, has a track record, uses trust accounts and has good market exposure and feedback. And good luck!