Far From the Maddening Crowd(funding)

Before we begin, let me emphasize that crowdfunding is a real word. Just ask the Oxford American Dictionary. They have Oxford in their title, so they ought to know.

Historically various forms of crowdfunding can be traced back to the 17th Century, starting with early forms of subscription systems for the publication of works by Martin Luther. This link to the Reformation is not surprising since crowdfunding carries with it a certain inherent rejection of hierarchical authority. Part of the modern appeal for crowdfunding is its libertarian appeal, as it holds out the possibility of a level playing field. All projects are born equal in the eyes of Kickstarter.

The modern form of crowdfunding started in 1997 when the British rock band Marillion raised $60,000 for their U.S. tour from fans via the Internet. This success was quickly followed by the indie filmmaker Mark Tapio Kines http://www.marktapiokines.com/ who used a similar system to raise $125,000 for his production of the movie Foreign Correspondents. Many people in the traditional investment community were less than impressed by an approach that they viewed as quirky, wrong headed, and just plain weird. Mostly they ignored it and assumed it would go away.

Then, from about 2001 to 2010, crowdfunding went through a steady but relatively quiet period of development. Sites like Kickstarter, IndieGoGo, RocketHub and SellaBand successfully developed crowdfunding models for everything from movies to rock bands to quilting societies. The crowdfunding model went through a phase of slow, very steady growth. Then, around 2010, it blasted through the stratosphere.

Today, crowdfunding has evolved as a major approach to fund raising for everything from software development to filmmaking and all points in-between. Even the Girl Scouts crowdfund. The predominant crowdfunding model to have emerged is the donation model. You post your project, list the time-line during which you need to raise the money and set the basic parameters of how much people can contribute. In many ways it is like dumping loose change into the Salvation Army bucket around Christmas time (minus the annoying bell ringing).

Except that it isn’t exactly a donation, not in the big D sense used by the IRS. The donors cannot write this off their taxes unless the project is covered by a tax-exempt status. That is why the correct term for these donations according to the IRS is gifts. In the tax universe, the word donations opens up lots of possible legal issues whereas gifts are simply nice things to receive. So the real term should be gift model crowdfunding. However, this legal correction is not used by anyone except a few of us quirky folks who like to nitpick.

The donation model has been successful enough to attract lots of interest. Especially from Hollywood studios. Not directly, but indirectly. Most Hollywood companies want only to make a few tent-pole movies per year with mega-budgets and production costs that would wipe out most medium sized countries. However, the studios don’t exactly object to some amount of low budget movies being made within the system as long as they are not really made (in other words, financed) within the system. So suddenly crowdfunding is being co-opted for basic lower cost Hollywood filmmaking. The successful Veronica Mars movie campaign was an important forerunner to this approach.

So, Hollywood is finding a way to enter the crowdfunding universe while simultaneously off-loading the financial cost of making low budget movies. That is half-OK. It does bring a lot of attention to the process. Big names will always attract the press. It could be a common tide that floats all boats. Too bad the average indie is best described as a kayak while the established crowd more resembles a yacht. A small one, perhaps (take for example Zach Braff, who could be described as a 26 foot “yacht,” at the dividing line between boat and yacht). Either way, these Hollywood vessels require a lot more water from the tide and pretty much leave all the kayaks in their wake.

But, that is also half-OK. Except that the entire crowdfunding system is about to be altered. The donation model will soon be changed into the equity model. At least, it will be whenever the SEC gets around to announcing the new rules. Although the SEC recently announced that startups can begin to advertise under the JOBS Act in about 60 days, it would appear that the impending announcement of the SEC rules on crowdfunding has been slowed down by internal political issues. But, no matter what, the equity-model is about to be imposed and there are already grave concerns about how it will affect the crowdfunding universe. (The Forbes article “The Trouble With Crowdfunding” by Brian Korn is worth a read, if only to gauge the current attitude towards crowdfunding in the securities market. A lot of those folks just don’t like the whole idea.)

It is possible that the SEC will allow both models to co-exist under certain restrictions (I have heard a variety of figures proposed as a cap on donation model crowdfunding). But the incoming equity model is designed for start up ventures and will involve an extremely different approach. It will be a lot less indie friendly since it will require massive amounts of more rigorous legal work and more extensive corporate structure. But in some ways, it will be more user friendly for the established operators who are already adapted to the corporate structure and looking for the type of financial ranges that the equity-model is designed to accommodate, basically $1 million to just under $100 million.

Which will favor the yachts over the kayaks.