Get With the Crowdsourced Funding

While looking for a way to keep struggling students from dropping out of court-reporting school, Matthew Thomas hit on an idea.

Thomas, a technical officer at the Court Reporting Institute of Louisiana in Baton Rouge, conceived of software that would let three students transcribe a single recording simultaneously, an activity that could speed up their learning process and get them earning money right away, both of which could boost their confidence so they’d stick with the school’s program.

There was just one problem: Thomas had no money to turn his idea into a product.

So he did what thousands of other small- and mid-sized businesses are doing when they can’t get financing anywhere else. He used the Internet to put his plea for $80,000 in startup funds in front of the online masses.

Thomas pitched his project and funding request on a website called 40billion.com, one of a number of crowdsourced funding sites that have popped up in the past few years.

While Thomas’ request didn’t raise any cash, it did connect him with software developers who are helping make a version of the court-reporting software a reality.

Once used mainly to get suggestions for restaurants, music downloads or vacation destinations, crowdsourcing has hit the financing business.

It’s a significant development at a time when banks are still reticent to lend, private investments have dried up and venture firms remain extremely selective, looking to fund ventures with CEOs or board members who’ve built companies in the past.

As a funding source, crowdsourcing is so new that it’s unclear how much money it has raised. 40billion.com says the ventures listed on its site earned a total of $25 million in the 18 months ended in September. Other funding sites won’t disclose their numbers, but say they have listed thousands or tens of thousands of requests since going live over the last two years.

How Crowdsourced Funding Works
Crowdsourcing platforms such as 40billion.com, Kickstarter, RocketHub, and IndieGoGo let companies or individuals chip in as little as $1.

It’s not uncommon to see a single project with hundreds or even thousands of donors, many of whom do it only for the perks. At IndieGoGo, donors receive merchandise discounts and other non-cash items, says Slava Rubin, the company’s co-founder. “A jewelry manufacturer might offer exclusive items for purchase or a special discount,” he says. Other donors get involved for nothing more than bragging rights, says Dave Lavinsky, co-founder of business planning consulting firm Growthink, “The main reason someone gets involved with crowdsourced funding is because they are rooting for the underdog,” he says.

There are also plenty of people looking for a return on their investment. Those investors are more likely to frequent crowdsourcing facilitators such as 40billion.com and MicroVentures Marketplace. At 40billion.com investors have three options: making a donation, lending up to $99,000 or providing an unsecured promissory note of up to $1 million. The latter two options require companies that receive loans to repay them in full with interest.

At MicroVentures, accredited investors take an equity position in companies they fund, and benefit if the businesses go public, are acquired or merge with another enterprise. Under any scenario, investors can earn their money back plus a profit. Of course, there’s no guarantee that will happen, and if it does, it could take years, says Bill Clark, MicroVentures’ CEO. “We definitely go over all the risks in the private placement summary,” he says. “A company may never come to a liquidity event, or it might take a very, very long time.”

What it Costs
Even companies that get money donated through a crowdsourcing facilitator pay a fee equal to a small percentage of the money they raise. Kickstarter, for example, charges 5 percent of a successful fund, while IndieGoGo.com charges 4 percent, or 9 percent for projects that don’t meet funding goals. For direct loans, 40billion.com charges a setup fee plus interest rates of up to 5 percent; for commercial paper offers the company charges 3 percent to 15 percent. MicroVentures charges companies 10 percent of the offering amount paid, but only on completed deals.

Michealene Risley, founder of Fresh Water Spigot, a Woodside, California, movie production company, recently used IndieGoGo.com to raise $25,000 for Tapestries of Hope, a film about rape and sex abuse whose total cost was in the mid-six figures.

But the IndieGoGo.com placement turned out to be as worth far more, Risley says. After the project’s listing on IndieGoGo.com went social, Fat Box Films donated $100,000 worth of post-production work and Warner Bros. executives volunteered to create an electronic press kit. “What we got should have cost in the low seven figures,” Risley says. “That’s the thing about crowdsourced funding: It opens you up to other potential investors.”

In addition to fees, any funds raised are taxable, says Growthink’s Lavinsky. Just how much depends on the crowdsourcing platform, the amount raised and whether a company is pre-selling goods, he says. Even companies that accept $500 in exchange for a perk such as naming a cupcake – something a Youngstown, Ohio bakery offered its funders – might have to pay taxes on it, and should consult with their lawyers and tax accountants.

Not every company that tries crowdsourcing funding is successful. But like the Louisiana court-reporting school inventor, even they see value in the process.

Edwin Tembo, founder and president of Edwin-T Golf Inc, a Bellevue, Nebraska, maker of upscale golf equipment used 40billion.com recently to request $99,000 for website development and new product engineering. While the bid was not successful, Tembo says he will try crowdsourcing again. “It's the simplest way to raise funds and poses the least risk to the entrepreneur.”