Can You Finance and Grow a Small Business Through Crowdfunding?

I have received more inquiries recently about the possibility of using crowdfunding to fund a business.  Crowdfunding is a method of using small donations from the public as a way to raise money without losing control over a project.  It has been used successfully to fund many different types of projects over the past few years including movies, music, fashion, and art.  Now that same model is starting to be applied to business ownership - but that is a much different and risky proposition. Here's why. If you have never seen crowdfunding in action, you should check out sites like Kickstarter, RocketHub, and Quirky which allow artists, designers, inventors, writers, and others to raise money to fund some creative project they are working on.  Donations are pledged online and, once a certain set amount is reached, the project gets funded by those small donations.  The key here is that backers of the project are making a donation to support the project but they receive no ownership in the project other than perhaps getting a free copy of the finished project as a gift.  But this simplicity is what makes the project-based model successful.  First, potential backers can easily wrap their heads around, say, a new short film or a book, and donating a small amount of money is a low risk proposition.  So a project gets completed, and backers may get a free copy of the project to keep.  A win-win.

But now companies are trying to expand the model beyond project financing to funding business concepts, which can be another avenue to funding without turning to angels or VCs.  The problem with taking money from a large number of people in exchange for ownership in a company is that this is exactly what the U.S. securities laws - both on a federal and state level - are guarding against.  In general, any securities sold in a company must either be publicly registered or must qualify for one of the enumerated registration exemptions.  Generally speaking, selling ownership in a company to people without a large net worth (so-called "unaccredited investors") may trigger a number of disclosure and registration obligations on the company, and specific laws of each state where investors are located will have an effect as well.  As the number of investors and states involved goes up, so do the costs.  So tackling a financing project like this should be done with the careful counsel of a securities attorney because these rules can be treacherous to navigate and could result in penalties and rescission.

Some may opt for services from companies like Profounder, which was recently launched to provide assistance with this kind of financing for a flat or small percentage fee (in addition to all of the filing fees).  Sounds like a great option for companies to raise money, but be very careful here.  The securities laws were written pre-Internet, and are certainly not optimized for the rapid changes in technology.  Just because you can do it does not mean you can get away with it.  And compliance requirements under state securities ('blue sky") laws vary and are notoriously different.  Again, seek out an experienced securities lawyer to help guide you through.

Have you tried crowdfunding?  What was your experience like?