Although traditional crowdfunding has been around for some time a new kind of crowdfunding, one which allows investors to actually purchase an ownership stake and gives them the opportunity to make a profit from their investment, may be about to take the music industry by storm.
Guest post by Richard Brownstein, CFP of The Sound Entrepenuer
Equity-based crowdfunding has become an increasingly popular funding option for arts and entertainment entrepreneurs in recent years—and its popularity may be about to explode.
The reason: Until recently, only very wealthy investors who were deemed to be “accredited” by the SEC were able to participate in equity crowdfunding ventures. That all changed in October, when a new rule allowed non-accredited investors to join the party. Now, just about anybody looking to invest in a film, live production or other entertainment project can do so.
Equity crowdfunding was a key topic during a recent panel discussion I attended, “The Business of Media and Entertainment 2015,” moderated by New York City accounting firm Marks Paneth. The panel included Chris Cacace and Richard Stern (both partners with Marks Paneth Theater, Media and Entertainment Group), Robert Green (founder of Another Green World Productions), Joanna Stone Herman (managing director at DeSilva+Philips), and Alan Sacks (a partner at Frankfurt Kurnit Klein & Selz, PC).
It also featured Maxolev Productions co-founder and Tony Award winner – Howard Kagen—who successfully used crowdfunding to raise money for On The Town.
Here’s a recap of what this esteemed group had to say about the pros—and pitfalls—of equity crowdfunding:
- Equity crowdfunding is not Kickstarter and Indiegogo. The most well-known crowdfunding companies are rewards-based: People give money to projects they think are cool, and in return they get exclusive rewards—which might range from basic (t-shirts) to big (a paid visit to a movie set) depending on the amount donated.
Equity crowdfunding is fundamentally different. Akin to traditional angel investing but on a bigger scale, it involves offering to a large number of people equity in a business or venture in exchange for their money. Equity crowdfunding investors don’t want swag—they want an ownership stake and to make a profit on their investment.
- The new non-accredited investor rule makes it easier than ever to raise capital. Arts and entertainment entrepreneurs looking to fund their projects can now send out e-mail blasts, put up banner ads on websites, and use online crowdfunding portals like Crowdfunder or RocketHub to get the word out to the world—and they can now accept capital from virtually anyone. Although SEC filings are required in most cases, entrepreneurs don’t have to get SEC approval to ask the masses for money via the Internet.
- There are two main tiers of non-accredited investor equity crowdsourcing options to consider.
- Tier 1 allows entrepreneurs to crowdfund up to $20 million over a 12-month period from any type of investor—with no limit on the amount of money they can gather from each investor. Entrepreneurs using this approach have a state registration requirement, but don’t have to provide audited financial statements or annual reports—which could result in significant cost and time savings.
For these reasons, Sacks stated that this route may be best for entrepreneurs looking to raise money for a single production.
- Tier 2 allows $50 million to be raised over a 12-month period from anyone. However, this tier comes with a per-person limit: Each non-accredited investor can invest up to 10% of his or her income or net worth (whichever is higher). That means someone has to review and confirm that each investor follows the rules. Entrepreneurs also must provide audited financial statements and reports on an ongoing basis.
Those additional tasks mean this approach may be best suited to operating companies looking to produce multiple films or performances that require ongoing access to capital over time, said Sacks.
- Crowdsourcing comes with potential pitfalls and issues. When entrepreneurs bring in any investor, they need to set expectations about the level of access and input that investor has in the overall entrepreneurial mission. It’s common for angel investors and others to try to exert significant control and bend the entrepreneur’s vision to match their own. Obviously that problem could grow exponentially when bringing in scores or even hundreds of crowdsourced investors—any number of whom might “have a few notes” to share.
In addition, non-accredited small investors who have little or no experience investing in start-ups, movies, plays and other risky ventures may be more likely than affluent angel investors or professional VCs to feel “burned” if a production flops—and may be more likely to sue for damages (real or perceived).
- Crowdfunding has big benefits beyond the cash. One of the best things about courting “regular people” through crowdfunding is the ability for entrepreneurs to build a devoted, dedicated community of fans who are motivated to make the project a big success. As Sacks pointed out: “You're creating an audience of people who are extremely vested—not just invested, but vested—in the outcome of the production. And there's no better support for you than a peer-to-peer recommendation. If somebody has invested in something, they'll deputize within their community to ensure that they, their two friends, and everybody else goes to see the film.”
Bottom line: The investors become marketing evangelists—generating more buzz and awareness than the priciest marketing campaign could.
One caveat: To create a raving fan base, be prepared to stay in constant contact with investors through emails and updates. Nothing turns a crowdsourced mob angrier than if they feel they’re being ignored—so keep feeding the beast with status reports, video updates and exclusives.
There’s no question that equity crowdfunding is going to be a big deal for arts and entertainment entrepreneurs in the coming years. Getting up to speed now can help entrepreneurs prepare to tap into this potentially valuable resource if, and when, the time is right.