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With the proliferation of Kickstarter, IndieGoGo, GoFundMe and others, many small businesses are beginning to view crowdfunding as a viable revenue source. Globally, crowdfunding accounted for $5.1 billion in revenue. There are currently over 112 active crowdfunding platforms located in Canada. As more and more businesses launch crowdfunding initiatives, it is important that they understand the risks and potential pitfalls associated with this type of fund raising

What is Crowdfunding?

Crowdfunding is the raising of funds through small contributions from the general public using the internet and social media. Individuals or companies can set up profiles on a wide-range of internet-based platforms to explain their pitch and request funding. The types of projects which request funding are vast, ranging from disaster relief to for-profit business ventures.

Rewards-based, Pre-purchase-based and Donation-based Crowdfunding

Rewards-based, pre-purchased-based and donation-based crowdfunding are the most popular and well-known of models of crowdfunding. Rewards-based crowdfunding involves the funder receiving some type of reward after funding. Examples of rewards given in exchange for funding are project merchandise, invitations events or other tokens of appreciation. Often a rewards-based funding initiative will have different rewards depending on how much each is contributed. Rewards-based crowdfunding is general used both by for-profit and not-for-profit businesses business goal or product (eg. funding a movie or video game, building a community centre).

Pre-purchase-based crowdfunding involves the funder receiving their own copy of the product or application being funded from the company upon a successful funding campaign. High-tech and software products are specifically well suited for pre-purchase-based crowdfunding campaigns. Clothing companies have employed this model before making a run of a new product for a niche market, as having revenue from the pre-purchase can offset the high fixed costs of manufacturing a new piece of clothing. Generally, these campaigns involved products that have a pre-purchase cost of $50-$500. The funder is usually able to purchase the product at a discount to the price after the campaign. However, the funder has no guarantee that the project will be completed or he will receive the product on time and ‘as advertised’.

Donation-based crowdfunding covers altruistic giving with for initiatives such as disaster relief, charitable projects or helping a specific person who has been struck by tragedy. Funders should be aware that donation-based crowdfunding campaigns are often not submitted by organizations that are registered charities, so they will not be subject to a high level of oversight nor will they issue tax receipts.

Companies or organizations who wish to use rewards-based, pre-purchased-based or donation-based crowdfunding to finance a specific goal should carefully review the terms of the agreement with their funding platform. They should also take great care in preparing the print material and video content to be viewed by the potential funders to ensure that they do not misrepresent their proposal. Most importantly, they must consider whether this type of funding model is right for the project from a business and marketing perspective.

Equity Based Crowdfunding

The idea of a funder taking a small portion of equity in the company for funding a project is new to this area. Currently, the Ontario Securities Commission does not permit the equity based crowdfunding model. Proposed new legislation will allow companies to issue equity in exchange for crowdfunding of up to $1.5 million per year. These types of funding initiatives will be required to run on a registered funding portal and will limit funders to $2,500 per investment.

Currently, only accredited investor and offering memorandum exemptions exist in Ontario, both of which would generally be outside of the reach of many start-ups and small businesses and do not fit the crowdfunding model regardless.

Summations

For the right kind of company or product, Rewards-based, Pre-purchase-based and Donation-based Crowdfunding models may be a great way to raise capital. Furthermore, often the positive press associated with a successful crowdfunding campaign has more value than the funds. Whether this is a good avenue to pursue is a business decision, not a legal one. The various crowdfunding websites have standard agreements with their clients that you should read and understand, but there is not much legal wiggle-room; you either agree to their terms or you don’t use their portal.

Equity Based Crowdfunding is not currently permitted in Ontario, but will likely be allowed in the very near future. Any company considering this type of funding model would be wise to consult with a lawyer to understand the potential legal issues surrounding this model.

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