CROWDFUNDING, VENTURE CAPITAL, AND GOVERNMENT GRANTS
by Jennifer A. Grady, Esq. and Tristan Younghaus, Esq.
Starting a business can be an exciting, yet costly endeavor. Entrepreneurs need Startup capital to cover the cost of living expenses, salaries, overhead, legal fees, filing fees, marketing/advertising, shipping costs, and even production costs. There are numerous funding options available, from interest free loans to venture capital.
In this two part series, we explore the various options that are available for small business owners and entrepreneurs. In the event business owners and entrepreneurs are unable or unwilling to secure funding in the form of loans from family, friends, bank loans, or Small Business Administration (SBA) loans, they may want to consider exploring other sources of funding, such as crowdfunding, venture capital, and government grants.
According to website Indiegogo, “Crowdfunding is the process of pooling money from many different people to make an idea happen.” There are two types of crowdfunding: donation-based, and equity-based. While there are different types of crowdfunding platforms available, some websites blend donation and equity-based crowdfunding.
Last year the global online crowdfunding industry raised $5.1 billion for thousands of cash strapped businesses, charities, and Startups. According to Massolution’s 2013 Crowdfunding Industry Report, equity-based crowdfunding raises 40 times more per company than any other type of crowdfunding in the marketplace.
a. Donation-Based Crowdfunding
Donation-based crowdfunding is an online strategy in which business owners and entrepreneurs seek money from a large number of donors in exchange for rewards or pre-sale of products that are to be manufactured. This type of funding is attractive because it does not require that the owners give up any control of their company in the form of ownership shares to outside investors, unlike equity-based crowdfunding. Kickstarter, Indiegogo and GoFundMe are examples of donation-based crowdfunding.
Kickstarter is industry-specific and offers funding for entertainment, technology and the arts. Kickstarter requires that the person or entity forming the campaign set a stated fundraising goal and provide a deadline for the campaign. The borrower sets levels of pledge amounts and what each investor receives for their pledge. For example, if the donor donates $100, he or she could receive the first version of the manufactured product in exchange for the donation.
For smaller donation amounts, the donor could receive his or her name on the campaign website and social media pages. If the borrower reaches the donation amount requested, all of the donors’ credit cards will be charged and the borrower will fulfill the pledges. However, if the borrower does not reach the requested amount by the funding deadline, the investor’s cards are never charged and the campaigner receives no money.
On sites like Indiegogo, campaigners can receive the total amount of pledges earned, whether or not the fundraising goal is reached. Sites like Indiegogo take a portion of the sales that are raised. For example, on a “Fixed Funding Campaign”, if the fundraising goal is reached, Indiegogo takes 4% of the total amount raised. For a “Flexible Funding Campaign,” Indiegogo takes 9% of the total amount raised when a fundraising goal is not met. This encourages the campaigners to set realistic funding goals, and to campaign aggressively to meet those goals.
b. Equity-Based Crowdfunding
In contrast to the average fundraising effort where founders do not give up a percentage of ownership in exchange for the cash, Equity-based crowdfunding allows entrepreneurs to reach investors interested in purchasing equity in their Startup or other privately held small business.
Equity-based crowdfunding is similar to venture capital, because this type of lending is private equity given to the borrower through individuals in exchange for ownership in the Startup company. The main type of equity-based crowd funding relies on Title II of the Jumpstart Our Business Startups Act of 2012, which allows borrowers to publicly announce their request for funding over the Internet on websites, such as, CircleUp and AngelList. Borrowers go on these sites and have access to millions of potential investors as long as they are willing to publicly advertise their need for funding and verify the eligibility of the investors, which is required by federal law.
For more specifics, read this article on Equity crowdfunding.
2. Venture Capital
Venture capital refers to loans given to borrowers from private lenders to early-stage, high-potential Startup companies. This type of lending is attractive to new companies that are unable to secure bank loans and might be too small to raise capital in public markets. Generally, venture capital firms assume a high risk by lending to Startup companies. In exchange, venture capital firms request control over the Startup’s business decisions, in addition to a significant portion of the company’s ownership. Of the nearly 2 million new businesses that are created in the United States every year, only about 600-800 receive venture capital funding.
It is important to thoroughly research venture capital firms to ensure the firm has a good reputation and specializes in the relevant industry, and to do the proper due diligence before closing a deal. Sites like Crowdfunder connect entrepreneurs with investors around the world to help fund their business and fuel economic growth.
3. Government Grants
A Federal Government grant is taxpayer money that is given away through legislation passed by U.S. Congress and signed by the President. In some circumstances, government grants do not have to be paid back.
Government grants are funded by tax dollars and therefore require very stringent compliance and reporting measures to ensure the money is well spent. The Small Business Administration (SBA) has authority to make grants to non-profit and educational organizations in many of its counseling and training programs, but does not have authority to make grants to small businesses. Announcements for the counseling and training grants appear on http://www.grants.gov.
Some business grants are available through state and local programs, nonprofit organizations and other groups. For example, some states provide grants for creating energy efficient technology; expanding child care centers; and developing marketing campaigns for tourism. These grants are not necessarily free money, and usually require the recipient to match funds or combine the grant with other forms of financing such as a loan. The amount of the grant money available varies with each business and each grantor.
Of note, the SBA can also help facilitate a loan with a third party lender, guarantee a bond, or help an entrepreneur find venture capital.
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The Grady Firm attorneys specialize in business advising for small business and Startup owners, and can help them identify which sources of funding are most appropriate for their business needs.
To schedule a complimentary consultation with our expert attorneys, call (323) 450-9010, or fill out a Contact Request Form.