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Using Crowdfunding to Start Your Business

It could revolutionize how people raise money for small start-ups — or expose unwary investors to financial peril

But, like all start-up backers, crowdfund investors will be taking a risk: If the business hits its funding goal but later fails, it may take your cash with it. Neiss says investors will have protections, including access to financial documents and business plans. And companies that fail to meet funding goals must return investors' money, just as most donor-crowdfunded projects do. He also believes that the collective wisdom of the Web will weed out fraudsters and poor projects. "I think less than 20 percent will hit their funding goals," he says. (Kickstarter claims a 44 percent success rate.)

Consumer-protection advocates — including AARP — are wary of the dangers equity crowdfunding could pose for older investors, who are frequent targets of securities fraud. The fear is that con artists will soon be cold-calling with bogus offers from crowdfunded start-ups. In a March 2012 letter to Congress, AARP Senior Vice President Joyce Rogers warned that crowdfunding portals "could become the new turbo-charged pump-and-dump boiler room operations of the Internet age." Daniel Isenberg, professor of entrepreneurship practice at Babson Global, compares crowdfund investing to playing the lottery. Because of income limits (see box below), investors probably won't lose their shirts, he says, "but they are going to lose their socks."

Ready or not, equity crowdfunding is coming, as soon as the SEC rules are released: "This is the year for crowdfunding," says Heather Schwarz-Lopes of the equity crowdfunding portal EarlyShares. She expects the first offerings in 2014. To prepare, she recommends launching donation campaigns on Kickstarter, Indie-gogo or RocketHub, to learn the model and "hit the ground running once the rules are out."

That's exactly what Jim Martin did. He raised $10,000 in donations on RocketHub to build prototype Active Desks. He plans to demo the contraptions at corporate wellness centers. A future round of equity crowdfunding would let him go bigger in scale. "Instead of going into it with 100 bikes, you go in with 1,000 bikes," he says. "You hit the market hard."

Crowdfund Investing 101

The 2012 JOBS Act allows small businesses to raise money by selling equity or debt through online crowdfunding websites. The SEC could release regulations on equity crowdfunding by the end of 2013. This is how the process should work.

Q: How much money can a business raise?

A: Up to $1 million a year. That might sound like a lot for a modest start-up, but critics fear the cap will limit the number of businesses that can take advantage of crowdfund investing.

Q: How much can I invest?

A: Those with less than $100,000 in assets or income can invest 5 percent a year, or a maximum of $2,000, whichever is greater. Those with higher incomes can invest 10 percent a year, up to $100,000.

Q: Can I get my money back?

A: If the company fails to reach its funding goal, you won't be charged. If the funding campaign succeeds and the business later fails, however, your investment is probably gone.

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