Tapping the Power of Crowds

Crowdfunding -- pooling small donations from many individuals -- has been around forever. Politicians and nonprofits have been crowdfunding forever. They just haven't called it crowdfunding.

The method of leveraging crowds to fund or expand startups or projects has been defined in recent years by the proliferation of pledge-based sites such as Kickstarter and Indiegogo. But with the April passage of the Jumpstart Our Business Startups (JOBS) Act, equity-based crowdfunding is preparing to take center stage.

With these sites, an individual contributes a small amount of money in exchange for a small reward, such as a T-shirt or the finished product, whatever that may be.

Kickstarter, one of the best known crowdfunding sites, has raised millions for creative projects in the US. The indie rock band Allensworth, for example, is trying to raise $15,000 on Kickstarter to finish its "highly anticipated sophomore album." So far the band has drawn 88 "backers" and raised $4,183 -- far short of the goal it hopes to reach by tomorrow. In exchange for a $10 contribution, a backer will get a digital download of the full-length album when it's finished. Typically, people who donate larger amounts get a bigger reward.

CrowdFundingLive, a new pledge-based site, launched with a fundraising effort for Killing Buddha, a film project by Betsy Chasse. The project has raised $5,008 so far. Chasse is trying to raise $100,000.

The latest type of crowdfunding, which has gotten a leg up from the JOBS Act, allows an individual to invest money in a startup or a business expansion in return for an ownership stake. Indiegogo, founded in 2008, recently closed a $15 million round of venture funding, which it may use to expand into equity-based crowdfunding. The site handles pledge-based crowdfunding for a broad range of projects and small businesses in the US and other countries.

Equity-based crowdfunding carries a higher risk than the pledge-based variety. Where there is the opportunity to make money, there is always the risk of fraud. Investors also need to keep in mind that startups have a high rate of failure. The JOBS Act, though, puts limits on individual crowdfunding. People with a net worth of less than $100,000 are limited to investing $2,000 a year. Wealthier individuals can invest up to $100,000. Companies can raise up to $1 million a year through crowdfunding.

The Securities and Exchange Commission has until the end of the year to lay out the final ground rules for equity-based crowdfunding. In the meantime, companies are forming to serve what could be a booming industry.

"We're in a period of discovery and consolidation," says Sara Hanks, chief executive of CrowdCheck Inc. Hanks and Brian Knight started the company in January in anticipation of the passage of the JOBS Act. Their company is sort of like a certification company. Among other services, it helps protect investors by conducting background checks on startups and verifying the financials of companies that want to raise money through crowdfunding. "First and foremost, we view our job is to help prevent fraud in crowdfunding," Knight says.

CrowdCheck's tips for investors include recognizing the risks of investing and knowing where your money is going.

Equity-based crowdfunding will likely follow the pledge-based model, Hanks says. "It would look a lot like Kickstarter or Indiegogo." She cites Crowdcube Ltd. in the UK (where equity-based crowdsourcing is already up and running) as an example of what might develop in the US.