Published By Janet Gershen-Siegel at November 17th, 2017
There are several crowdfunding terms you show know. In Part 1, we talked about the basics, such as what a campaign is, and what perks are, including the pitfalls of certain types of perks.
Here in Part 2, we will talk about the types of crowdfunding there are, and touch upon how the law has become involved with the process.
Probably the best-known of all crowdfunding platforms is Kickstarter. Kickstarter is, by its own rules, solely for project creation, and not for charitable donations. This puts it squarely in the camp of rewards-based crowdfunding. That is, the project exists for the purpose of getting a new market to product/setting up a new business.
This form of crowdfunding offers rewards (perks), either physical or intangible. It can also serve as a means of pre-selling a product before there is even a prototype. However, until there is an actual available product, is it a sale, or not? While it is easy to try to dismiss such a concern as no big deal, well, not so fast.
The law may very well beg to differ.
In the United States, the sales of almost 100% of all goods come under the Uniform Commercial Code. This set of laws is identical everywhere in the country except in Louisiana, where it is still rather close.
The UCC covers any number of concerns with products. These include merchantability (can a product reasonably be sold) and fitness for a particular purpose. While it does not cover liability in case a product injures a person that can be another question, in case something like that happens.
When a product injures someone (in the law, this term is product liability), it does not matter whether the injured party directly bought the product or borrowed it from another or the like. However, at a certain point, it becomes such a tenuous and far-reaching relationship between product creator (that is, the manufacturer) and the final end user that questions as to cause and effect can arise.
While new products sold via crowdfunding are, without a doubt, sales, what about perks? In general, in contract law, a sale is an exchange of goods (or services) for a consideration. A consideration is essentially either a fee or its equivalent, such as through barter.
The consideration does not have to have anything to do with the goods on sale. That is, when it comes to value. A result, a transaction doesn’t stop being a sale just because the buyer got a really good deal, or a really bad one. Hence it can still be a valid contract even if you bought a new Rolls Royce for a dollar.
If a perk is worth $1 but is only available at the $10 donation level, what then? So if it’s a sale, then the UCC should apply. If the perk injures someone, then the question doesn’t really start to matter at first. It is only an issue if the end user ends up removed extremely far away from the project creator.
That can happen if an item is the subject of a sale or a swap. Or it could just be given away to someone else. Hence at that point, the question of if a perk is a sale could loom very large indeed.
These questions do not seem to have undergone litigation yet. It will be interesting to see what happens when, inevitably, they are.
When businesses look to hand over percentages of ownership in exchange for current financial backing, the term is equity-based crowdfunding. Kickstarter, for example, does not allow this, although platforms such as AngelList and Crowdfunder do.
After the passage of the 2012 JOBS Act, smaller companies have more freedom to crowdfund and hand over equity shares without quite so many Securities and Exchange Commission (SEC) filings as were needed before. This federal law opened up crowdfunding more. So that made it a far more attractive option for startups in particular. The SEC, naturally, has an interest in this species of crowdfunding.
In this form of crowdfunding, a charity solicits donations via a crowdfunding platform. There are either no perks or they are tiny. Or they may even be virtual or part of an experience of some sort. For example, lunch with someone or even a donated Skype call with a celebrity.
The best-known of these is probably GoFundMe, where project runners can either raise funds for themselves or for charities. Donation-based crowdfunding also encompasses the all-too common crowdfunding pleas cropping up these days. These are for everything from help paying medical or veterinary bills to attempts to get donors to fund dream vacations and honeymoons, or just fix the project runner’s car.
Without perks or pre-sales, there are no UCC considerations. However, of course there can be questions from state governments if a charity raises funds via crowdfunding and then someone just pockets the money.
In the absence of crowdfunding, startup founders often use bootstrapping to get their projects off the ground. Bootstrapping is just the use of personal finances to fund a new company.
The biggest advantage to bootstrapping is that a business owner does not have to give up any ownership in the company. The biggest disadvantage, of course, is the loss of a life’s savings is a very real possibility.
Crowdfunding in particular can serve as a means of minimizing bootstrapping although it probably will never eliminate it entirely.
One possibility is business credit lines. A credit line, or a line of credit (LOC), is an agreement between a bank or private investor that sets a maximum loan balance which a borrower can access.
A borrower can access funds from their line of credit at any time, so long as they don’t exceed the maximum set in the agreement, and as long as they meet any other requirements of the finance institution or investor such as making on time payments.
Credit lines offer many unique benefits to borrowers including flexibility. Borrowers can make use of their line of credit and just pay interest on what they use, compared to loans where they pay interest on the total borrowed. Credit lines can be re-used, so as you acquire a balance and pay that balance off, you can use that available credit again, and again.
Credit lines are revolving accounts similar to credit cards, and are comparable to various other kinds of funding like installment loans. In many cases, lines of credit are unsecured, much the same as credit cards are. There are some credit lines that are secured, and accordingly easier to qualify for
Credit lines are the most regularly requested loan type in the business world although they are very popular, authentic credit lines are scarce, and hard to find. Many are also very hard to get approval for, calling for good credit, good time in business, and good financials.
But there are various other credit cards and lines that few people know about that are available for startups, bad credit, or even if you have absolutely no financials.
Many credit line types which most business owners picture come from traditional banks and conventional banks use SBA loans as their key loan product for small business owners. This is due to the fact that SBA guarantees as much as 90% of the loan in the event of a default. These credit lines are the toughest to get approval for because you must qualify with SBA and the bank.
Even companies which could do well with crowdfunding should build business credit.
Business credit is credit in a company name, in connection with the company’s EIN number, and not the owner’s Social Security Number. When built correctly, a business owner can get business credit without any personal credit check and without a personal guarantee.
You can get three types of business credit cards. Vendor credit offers net 30 terms to kick off a business credit profile. With store credit, you can get credit cards with high limits at most retail stores.
And with cash and fleet credit, you can get Visa, MasterCard, American Express cards you can use anywhere. And you can get them without any credit check or guarantee. Limits are usually $5,000 – $10,000 to begin, and can exceed $50,000.
Business credit is also helpful because it serves as an asset. It is a valuable piece of any company.
Business owners looking to try crowdfunding should understand the terminology. And they should also understand the very real risks that can accompany this form of financing.
Crowdfunding can seem exciting and modern. But it will most likely be business credit and plain old hard work that actually pays the bills.