Crowd Funding

Definition;

Crowd Funding (sometimes called crowd financingcrowd sourced capital, or street performer protocol) describes the collective cooperation, attention and trust by people who network and pool their money and other resources together, usually via the Internet, to support efforts initiated by other people or organizations. Crowd funding occurs for any variety of purposes,  from disaster relief to citizen journalism to artists seeking support from fans, to political campaigns, to funding a startup company or small business or creating free software.

History

The crowd funding approach has long precedents in the sphere of charity. It is receiving renewed attention from both commercial and social entrepreneurs now that social media,online communities and micropayment technology make it straightforward to engage and secure donations from a group of potentially interested supporters at very low cost.

One of the pioneers of crowd funding in the music industry have been the British rock group Marillion. In 1997 American fans underwrote an entire U.S. tour to the tune of $60,000, with donations following an internet campaign – an idea conceived and managed by the fans before any involvement by the band. Marillion has later used crowd funding with great success as a method to fund the recording and marketing of several albums, Anoraknophobia, Marbles and Happiness Is the Road.

Crowd funding in the film industry was pioneered by French entrepreneurs and producers Benjamin Pommeraud and Guillaume Colboc from company fr:Guyom Corp. when they launched a public Internet donation campaign in August 2004 to fund their film, Demain la Veille (Waiting for Yesterday).Within three weeks, they managed to raise nearly $50,000, allowing them to shoot their film. It was the first structured Internet-based crowd funding initiative, involving a dedicated financing website and offering counterparts such as credits, DVDs, or presence on the shoot.

Four months later, on the other side of the Atlantic, Spanner Films started the production of its climate change documentary The Age of Stupid.  It’s team, headed up by Franny Armstrong, successfully raised more than £900,000 over a period of five years (December 2004 to 2009, the date of release) to cover both the production and promotion of the film. The film’s crew worked at very low wages but also received crowd-funding “shares”. Under the terms of the crowd-funding contract the investors and crew are paid once a year for ten years from the release of the film.

The Cosmonaut is another landmark example of crowd funding in the film industry: its Save The Cosmonaut campaign raised €130,000 within only a week. Throughout the time, the film has raised a total sum of €300,000 by means of crowd funding, making it one of the most ambitious projects to this day.

Crowd funding’s earliest known citation was by Michael Sullivan in fundavlog on August 12, 2006: “Many things are important factors, but funding from the ‘crowd’ is the base of which all else depends on and is built on. So, crowd funding is an accurate term to help me explain this core element of fundavlog.”

Earlier, other and Related Definitions

Someadvocate that crowd funding does not include investments, and only includes the categories of donations, memberships or pre-ordering of products, giving none of the contributors a future stake or monetary reward of any kind. MediaWave debates whether or not crowd funding should be considered an investment: Crowd funding definition may however be restricted to pooling of resources together at the grassroot with a framework for rewards and for the purpose to initiate and or found an investment, where common desire and trust are the most important driving force for participation. Money contributed by group of individuals (large or small) without a framework for future stake may not be defined as crowd funding because such contributions pass only as donations.

There are questions about the legality of taking money from “investors” without offering any of the security demanded by legitimate investment schemes. Sites such as ArtistShare, Kickstarter,Pledgemusic, and Funding4Learning have a failsafe. They hold funds in an escrow account. If the nominated target isn’t reached, all funds are returned to contributors. While sites such asFondomat, RocketHub, IndieGoGo and Sponsume allow projects to keep all the funds raised.

Investors are given something for their money – so in a legal sense, they have paid for and received something. The Tunnel is selling frames of film for one dollar each. Pioneer One gives you the theme music or a special edition download.

Micropatronage is a system in which the public directly supports the work of others by making donations through the Internet. In use as early as 2001, the term was popularized in 2005 by blogger Jason Kottke when he quit his day job as a web designer and spent a year blogging full time, living off the voluntary donations of his readership. Micropatronage differs from traditional patronage systems by allowing many “patrons” to donate small amounts, rather than a small number of patrons making larger contributions.

In webcomics, micropatronage plays a large part in supporting both the author and the site itself, and it has become common in webcomics to see authors asking for donations from fans beyond a certain level of popularity.

Contemporary Applications

Crowd funding is being experimented with as a funding mechanism for creative work such as blogging and journalism, music, and independent film, and also for funding a startup company. Community music labels are usually for-profit organizations where “fans assume the traditional financier role of a record label for artists they believe in by funding the recording process”.

Since pioneering crowd funding in the film industry Spanner films have published a useful ‘how to’ guide.

Innovative new platforms, such as RocketHub, have emerged that combine traditional funding for creative work with branded crowdsourcing – helping artists and entrepreneurs unite with brands “without the need for a middle man.”

Approaches

An entrepreneur seeking to use crowd funding (example for Seed Money) typically makes use of online communities to solicit pledges of small amounts of money from individuals who are typically not professional financiers. A range of variations are possible, for example:

  • The solicitation could be to back an idea with no direct material return offered to those making a pledge. This type of crowd financing has long precedents including artistic patronage and the normal activities of charity fundraising. Sometimes a threshold pledge approach is used, in which all pledges are voided unless the threshold amount is reached before the deadline.
  • Another approach invites a display of sponsorship in return for the cash pledged. A widely documented internet-based example is The Million Dollar Homepage.
  • The solicitation could be to offer a loan (microfinance) e.g., Kiva, Zidisha, etc.
  • Some kind of quasi-equity investment could be offered, though any such scheme would need to avoid falling under any applicable financial regulations regarding making an initial public offering. One such scheme was introduced in February 2010.
  • Straightforward equity investment. When multiple parties are involved, this can involve a lot of work. There are platforms to make this easier.
  • A threshold pledge system as above, but rewards are offered in return for gifts or donations.

Intellectual Property on Crowd Funding Sites

One of the challenges of posting new ideas on crowd funding sites is there may be little or no Intellectual Property (IP) protection provided by the sites themselves. Once an idea is posted, it can be copied. As Slava Rubin, founder of IndieGoGo said: “We get asked that all the time, ‘How do you protect me from someone stealing my idea?’ We’re not liable for any of that stuff.” Inventor advocates, such as Simon Brown, founder to the UK based United Innovation Association, counsel that ideas can be protected on crowd funding sites through early filing of patent applications, use of Copyright and trademark protection as well as a new form of idea protection supported by the World Intellectual Property Organization called Creative Barcode.

Patent Disputes

On September 30, 2011, the crowdfunding site Kickstarter filed a request for declaratory judgment against Fan Funded who owns U.S. patent US 7885887, “Methods and apparatuses for financing and marketing a creative work”. Brian Camelio, founder of ArtistShare, is the inventor on the patent. KickStarter says it believes it is under threat of a patent infringement lawsuit. KickStarter has asked that the patent be invalidated, or, at the very least, that the court find that Kickstarter is not liable of infringement.

Pros and Cons

Proponents of the crowd funding approach argue that it allows good ideas which do not fit the pattern required by conventional financiers to break through and attract cash through the wisdom of the crowd. If it does achieve “traction” in this way, not only can the enterprise secure seed funding to begin its project, but it may also secure evidence of backing from potential customers and benefit from word of mouth promotion.

Against these advantages is the requirement to disclose the idea for which funding is sought in public when it is at a very early stage. This exposes the promoter of the idea to the risk of the idea being copied and developed ahead of them by better-financed competitors.

Legal Regulation

Another significant downside to crowd funding is the possibility of getting ensnared in various securities laws, since soliciting investments from the general public is most often illegal unless the opportunity has been filed with an appropriate securities regulatory authority, such as the Securities and Exchange Commission in the U.S., the Ontario Securities Commission in Ontario, Canada, the Autorité des marchés financiers in France and Quebec, Canada, or the Financial Services Authority in the U.K. These regulators can have different ways of determining what is and what is not a security but a general rule one can rely on (at least in the U.S.) is the Howey Test. The Howey Test says that a transaction constitutes an investment contract (therefore a security) if there is (1) an exchange of money (2) with an expectation of profits arising (3) from a common enterprise (4) which depends solely on the efforts of a promoter or third party. Clearly, under this standard, any crowd sourcing arrangement in which people are asked to contribute money in exchange for potential profits based on the work of others would be considered a security. As such, the applicable investment contract would have to be registered with a regulatory agency (such as the S.E.C.) unless it qualified for one of several rule-laden exemptions (e.g. Regulation A or Rule 506 of Regulation D of the Securities Act of 1933, or the California Limited Offering Exemption – Rule 1001 (also known as S.E.C. Rule 1001)). The penalties for a securities violation can vary greatly and depend in large part on the amount of profit obtained by the “promoter,” the damage done to the investors, and whether a violation is a first time offense. However, a violation may result in both civil and criminal penalties, a return of any profit made and sometimes a lifetime ban from work in the securities industry. According to Section 5 of the Securities Act, it is illegal to sell any security unless such a sale is accompanied or preceded by a prospectus that meets the requirements of the Securities Act.

In February 2011, a group of entrepreneurs banded together and formed ‘The Startup Exemption’ with the goal to lobby Washington, DC to update the Federal Security Laws to make it legal for entrepreneurs to use crowdfunding for a limited amount of early-stage equity-based financing. With the assistance of the Small Business and Entrepreneurship Council (SBEC) they partook in two hearings on Capitol Hill. Their framework was the basis for the Entrepreneur Access to Capital Act (H.R. 2930) introduced by Rep. Patrick McHenry (R-NC). In November 2011, the U.S. House of Representatives passed H.R 2930 in a vote 407-17. It reduces restrictions on small-scale crowdfunding of for-profit businesses currently present in state and securities law. The Democratizing Access to Capital Act (S.1791) was awaiting action in the U.S. Senate.

Sources; Wikipedia and other encyclopedias

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