Published By Janet Gershen-Siegel at November 17, 2017
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 even a prototype has been made. 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.
In the United States, the sales of almost 100% of all goods are covered by 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, including 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 is called product liability), it does not matter whether the injured party directly purchased 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 (either a fee or its equivalent, such as through barter). The consideration does not have to be commensurate with the goods being sold. That is, the transaction doesn’t stop being a sale just because the buyer got a really good deal, or a really bad one.
If a perk is worth $1 but is only available at the $10 donation level, what then? If it’s a sale, then the UCC should apply. If the perk injures someone, then the question doesn’t really start to matter until the end user is extremely far-removed from the project creator.
These questions do not seem to have been litigated yet. It’ll 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 that is called 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, making 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. 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, for everything from help paying medical or veterinary bills to attempts to get donors to fund dream vacations and honeymoons, or just get the project runner’s car fixed.
Without perks or presales, there are no UCC considerations. However, 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 used 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 an entrepreneur 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 is meant as a means of minimizing bootstrapping although it probably will never eliminate it entirely.