Crowdfunding has been touted as a way for smaller enterprises to bypass traditional lending and go right to customers for funds. While this may seem like a dream come true for businesses with few resources, there are several logistical issues.
1. Due Diligence Requirements
The JOBS Act, which makes crowdfunding legal for corporations, has extensive due diligence requirements. This includes background checks on both large stockholders and management.
2. Frequent Reporting
Companies that choose this method of fundraising must file reports with the SEC. Depending on the complexity of a campaign, this can take up a great deal of time and effort.
3. Difficulty Appealing To Potential Investors
Under the JOBS Act, businesses can’t advertise their funding campaigns. This makes it incredibly difficult to raise funds, as campaigns rely on a large number of small pledges. If you can’t get the word out about your company, you can’t convince apathetic internet users to spend their money. The only exception to this rule is that you can direct investors to the funding portal you’re using. While this may help people who already have a large audience, such as online influencers, it doesn’t do much for entities with little internet presence.
4. Disclosure Requirements
The JOBS Act puts several disclosure requirements in place:
- Documents must be filed with SEC
- Must be filed 21 days before your first sale
- Must contain audited financial statements detailing raises over $500,000
- Restrictions on Funding Portals and Broker-Dealers
Funding portals and broker-dealers are essential to funding campaigns. They are a single point of contact where investors can pledge their funds. A few popular examples are Kickstarter, IndieGoGo, and GoFundMe. All campaigns have to go through funding portals or broker-dealers that are registered as such.
The JOBS Act also outlines several restrictions on how these broker-dealers and funding portals may function and how businesses can use them. For example, these entities aren’t allowed to act as investment advisors, solicit investments or base employee compensation on sales.
6. Funding Caps
Most frustratingly, there are limitations to how much investors can contribute and how much money a business may make from campaigns. For example, investors with incomes of under $100,000 can’t pledge more than 5% of their net worth or annual income, whichever is greater. On the other end, businesses can’t make more than $1 million per year using this fundraising method.
Crowdfunding may seem like a quick way and simple way to raise money, but there are a lot of pitfalls. With the current legislation, it may be more trouble than it’s worth for many businesses.