Mention the word “crowdfunding” and most people immediately think of the internet funding platform, Kickstarter. While Kickstarter is a type of crowdfunding, it is not the only type. Crowdfunding is a method of funding a project or business by raising small amounts of money from a large number of individuals, usually accomplished over the Internet. There are four main categories of crowdfunding and they are identified based on the type of return (if any) the person who is investing is expecting to receive for their investment. The four categories are: (1) donation based; (2) rewards based; (3) debt based; and (4) equity based.
In a donation based crowdfunding campaign, the investor(s) (“crowd”) contributes money or other resources to the campaign without expecting anything in return. Donation based crowding funding works based for community projects, charities and other social causes.
In a reward based crowdfunding campaign, the crowd contributes money or other resources in exchange for various “rewards”. Often, these campaigns will have several “reward” levels based upon the value of the contribution. Normally, these “rewards” are products or services linked to the campaign, and which are offered for free or for a substantial discount. Reward based campaigns work well for consumer goods and other tangible products.
In a debt based crowdfunding campaign, the situation is slightly changed as the campaign is now looking to borrow money from the crowd. In exchange for the funds, the crowd is promised by the person/company running the campaign that they will be repaid the amount they lent pursuant to a specific scheduling outlying set time intervals and interest rates. These types of campaigns are popular with start-up business who do not want to give up equity in the business or who do not qualify for traditional funding.
The final crowdfunding campaign type is equity based crowdfunding, in which the crowd receive ownership in the company in exchange for their contributed funds. This process is similar to buying shares in a company. The expectation is that if the company does well, the crowd members will receive a return on their investment in the form of a dividend or other distribution from the company.
Equity based crowdfunding is useful to entrepreneurs and start-ups who need financing but seek an alternative to the traditional sources and investors. Equity crowdfunding in the U.S. has been on the rise since 2012 and is expected to become one of the biggest sources of funding in the future. However, the current legal and regulatory restrictions imposed by the federal government make equity crowdfunding complex and costly to facilitate.
Several states have stepped up to make equity crowdfunding easier for their residents, including Wisconsin, Indiana and Michigan, passing legislation to create a marketplace for in-state business and investors. The catch with all this new legislation is that the crowdfunding must be intrastate, meaning that it all must happen with-in a single state and that investors are not allowed to invest in campaigns from other states. The participating states are able set their own rules and regulations regarding equity crowdfunding, maintaining order and preventing fraud.
There is currently movement among small businesses and community organizations to bring intrastate equity crowdfunding to Illinois. Supporters claim that crowdfunding will encourage local entrepreneurs and stimulate the economy. According to data collected by Fundable.com., crowdfunding companies create one (1) new job for every $37,702 invested/donated and every $1 invested leads to $6.36 in revenue.
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