Wednesday, November 24, 2010

Alms for the Creative: Crowdfunding means passing on traditional funding to pass the collection plate

Move to change securities regulations could mean big changes in the micro-funding model
by Josh Gross - Boise Weekly -

Travis Swartz wanted to make a movie, but he didn't have any money. And while the Boise resident had made zero-budget films before, he wanted this one to be different and that meant he needed some dough.

He could have pounded the pavement shopping his script about an unloved janitor with eight days to live to aspiring producers and so-and-so's rich uncle looking for the $25,000 needed, but Swartz didn't feel right about it.

"If we're all being honest with independent film, it's not a smart investment. It's an investment of love," Swartz said.

Instead, he chose to delve into the growing world of crowdfunding, where small, individual contributions provide a new way of getting projects off the ground, ranging from independent films or music to a hobbyist's attempt to create nuclear fusion in his Brooklyn garage.

Though there are several different variations on the crowdfunding model, the idea is to use the web to pitch an idea and collect small donations to fund it. Essentially, a project manager --an artist, filmmaker, journalist, scientist, etc.--creates a project profile and pitch on a crowdfunding site--like Kickstarter or Indiegogo--then uses social networking to solicit small contributions from a large number of people. In return, contributors receive non-monetary gifts relative to the amount of their contribution.

"When I first started looking into crowdfunding I was uncomfortable with it because it seemed like handing out the hat for nothing, but I discovered that's not what it's really about," Swartz said. "It's like pay-in-advance. You get something in return."

For donating to Swartz's film, Nobody Cares, contributors would be rewarded with what amounted to tokens of appreciation. A smaller donation would get a signed DVD, where a larger donation would guarantee a luxury private screening and the donor's name in the credits as a financier. Essentially, Swartz was pre-selling tickets to and copies of a movie he hadn't actually made yet.

From a promotional standpoint, Swartz's crowdfunding campaign would have made the audience personally invested in the film's progress in the same way comic book fans obsessively follow every step of film adaptations.

"It's really important to build an audience into the filmmaking process," Swartz said. "The old way is to send [a film] out to festivals and hope it builds an audience. Crowdfunding is really a process of not just raising the money, but raising the money from the audience that is really going to appreciate it."

The combination of the promotional and financial benefits of crowdfunding may be so successful, in fact, that even established institutions with solid donor bases are looking to augment their budgets by passing the virtual plate. In Boise, for example, Boise Contemporary Theater recently used Kickstarter to produce its 2010-2011 season opener, The Krumblin Foundation.

And while members of Boise's artistic community are piling on the crowdfunding gravy train to cover the cost of albums, plays and even teaching expeditions to Kenya, what many don't realize is that they're also firing the opening shots in what could be a major revamping of the laws that dictate how funding is done in this country, from the arts to small business.

As things stand now, crowdfunding contributors are sidestepping longstanding laws of the land. They are considered "donors" and not "investors" and can only receive non-monetary gifts. If they were to benefit financially from their donation, it would be in direct violation of the Securities and Exchange Act of 1933, the law passed to prevent the sort of practices that brought on the stock market crash of 1929 and the Great Depression.

The act "Requires that any offer or sale of securities using the means and instrumentalities of interstate commerce be registered pursuant to the 1933 Act, unless an exemption from registration exists under the law."

No exemption exists for the type of small-scale projects crowdfunding is typically used for. Anyone who wants to offer financial returns must register with the SEC, a process often more complicated and expensive than the project itself.

"What those laws were protecting against was the oil speculators knocking on widows and doors," said Danae Ringlemann, co-founder and CFO of IndieGogo, a crowdfunding site that operates in more than 130 countries. "But that was an age when communication was literally knocking on doors. You had to get physical reports on how projects were running."

According to Ringlemann, the transparency brought by the Internet is the single biggest change since the laws governing these transactions were written. And though the Internet has provided tools to more effectively assess risk and track projects, the laws are still strictly enforced.

"We're not dealing with big amounts of money here," said Tim Kappel, a Nashville-based entertainment lawyer who specializes in crowdfunding. "There are ways to structure in protections for the creative investor. Meanwhile, you've got the stock market, which is a big roulette table and people treat it like a casino or a race track."

Kappel published a paper in the Loyola of Los Angeles Entertainment Law Review, explaining the differences and problems between what he calls "pure patronage" and "patronage-plus" models--the "plus" being financial returns.

"The U.S. market poses unique and significant legal obstacles--specifically laws governing gambling and the sale of securities--that could derail any effort to import a patronage-plus ex ante crowdfunding system for the recording industry," Kappel wrote.

Kappel translated that from law person to lay person.

"When you start offering a share of the profits that are created through the sale of distribution of the product, then you're dealing with investment laws," said Kappel. "If someone wanted to offer more than a tote bag, if someone wants to offer an investment, they can't. They would certainly run afoul of SEC laws. And that has to go through a ton of regulation as a public offering."

Aside from contributors' inability to make money, this creates an odd loophole in the process. Since contributors aren't legally investors, that also means they don't have any ownership or control. And while this is certainly an arrangement artists prefer, it also means that there's no back-end protection for contributors. If an artist doesn't follow through on a project, there isn't much that can be done about it. While some crowdfunding websites hold the money as pledges of support until a goal is reached, others do not, and almost universally, there are no guarantees that a project that has been funded will reach fruition. Theoretically, project managers are legally culpable, but since the average contribution hovers around $25, the chances of a lawsuit from contributors are minimal.

It's what Kappel calls the difference between a legally enforceable right and practically enforceable right.

In Kappel's paper, he cites European crowdfunding websites such as Bandstocks, which allows bands to sell 10-pound shares in their album projects. Bandstocks, however, provides back-end protection by suing on behalf of contributors should a project get dropped.

However, Ringlemann said dealing with a donor unhappy about incomplete projects hasn't yet been a problem for Indiegogo.

"It's always possible someone can take the money and run off to Bermuda," she said. "But the probability is incredibly low."

Ringlemann said the two things that make it unlikely are human nature and transparency provided by the Internet.

"No one raises money from 100 percent strangers," she said. "Crowdfunding can be a way to raise money from friends and family more quickly."

Ringlemann cited a crowdfunding campaign to buy a new computer for a student as a birthday present. Her friends all pitched in a few bucks and she had enough for a new computer within several days.

Ringlemann said in a typical campaign, initial donations by friends and family serve as a vetting process. People aren't quick to financially cross those closest to them. And while strangers may eventually donate to a campaign, it's unlikely to reach that point if friends and family aren't willing to risk a few dollars first. It's part of what Ringlemann calls a "social score."

"Right now, we're judged by a credit score," she said. "But over time, I think that is going to adapt to include how good you are at following through on things like Facebook and Twitter as a way of further assessing your credibility. When you see people with great followings on Twitter, they have them because they're doing good work."

Ringlemann said a crowdfunding scam is hard to run online simply because there are so many options, and a project manager's social score can be easily gauged by prior successes and failures listed on the project page.

That transparency is why the process has such appeal to both project managers and contributors and has been successfully employed for such a wide variety of projects.

Longtime BW columnist Ted Rall even used crowdfunding to raise $25,999 for his recent expedition to Afghanistan to cover the research costs of a new book. The money covered one month's expenses--an amount Rall claimed in his pitch video would normally prohibit reporters not backed by large corporate sponsors from making the trip. He and his colleagues, cartoon journalist Matt Bors and web cartoonist Steven L. Cloud, claimed to be the only unembedded reporters operating in the nation at the time.

For their part, Rall's 211 backers received, or will receive, gifts like signed copies of his book, original sketches and thank yous in the book's liner notes. One contributor bought dinner and drinks with the author for a cool $1,000.

Since crowdfunding appears to be an effective way to raise capital, small businesses are looking at how it could be used to their benefit. But under current SEC laws, such a venture would be illegal. That's why a growing movement is trying to change the law.

"Like everyone, I have more ideas than I pursue. And for as along as I can remember, I thought there should be a way for people to invest in me, in others, with small amounts of money. Not just as a means to do it, but as external motivation," said Paul Spinrad, project editor for Make magazine, who is leading the charge to change the SEC laws and make crowdfunding easier.

He tried to put that into action with the Premises Premises website, which was a rudimentary attempt at crowdfunding. Spinrad said it failed because the site didn't frame ideas well enough. Since then, more successful crowdfunding sites have incorporated the best elements of social networking.

When he learned about Kickstarter, Spinrad wrote several guest opinions on the popular blog about the potential of investing in intellectual property. People seemed interested, so he took that energy and decided to see what could be done with it.

He discovered that the SEC accepts public petitions, which are posted on the SEC website for public comment.

Spinrad decided to levy the crowd to push the SEC to write an exemption to the Securities and Exchange Act for investments of less than $100 using the comment process.

"Even if just 50 people submit comments, it's going to be way more than they've dealt with before," said Spinrad. "It's a backwater."

The exemption wouldn't cost anything, but it could open new ways for investors to make money.

"Securities deregulation, people are down on it right now," Spinrad said. "And generally I am as well, but this is not high-level insider corporate gaming. This is the kind of deregulation that a leftie can love."

Spinrad acknowledges that comment-bombing a site could backfire, but he feels the comment process is in line with the principles of crowdfunding, making it the ideal method.

"I don't want to antagonize the SEC," Spinrad said. "This is to inject it into public dialog. If they don't want to do that, that's their bad. But if it's a proposal worth consideration, then they should consider it."

It seems to be working. His campaign has levied 39 comments so far, including several from CEOs and an in-depth analysis of the exemptions potential from an associate professor of finance at Georgetown University. The American Sustainable Business Council, a prominent lobbying group, picked his cause as one of its official campaigns, and Spinrad even got an unsolicited letter from the White House Office of Science and Technology Policy encouraging him to attend and push for the exemption at an annual open forum the SEC holds to meet with small business leaders.

While Spinrad sees the exemption as a way for artists to fund projects, Jenny Kassan, co-director of the California-based Sustainable Economies Law Center--who is helping Spinrad with the petition--sees it from a different perspective. For her, this is the only way small businesses will ever be able to get a fair shake.

"If you care at all about supporting small, locally owned businesses in your community, this is a crucial issue," Kassan said. She contends that without it, large corporations will always have an advantage over mom-and-pop stores.

"A lot of people don't understand securities regulations in the first place, so they don't understand why we need to do this," she said. "But the more people realize how hard it is for a small business to raise money legally, and that people are not allowed to go out and ask their friends or their community for an investment, the more excited they get. Especially now, in this climate, when businesses are suffering."

In Kassan's view, the idea that people can freely stroll around dropping money on the lottery or in a casino, but that the government won't let them risk it on an investment is absurd.

"Let's leave it up to the people," said Kassan. "It's their $100. They're not going to die if they lose it."

Kassan sent a nine-page letter to the SEC in late June outlining the proposed changes in detail, including several caveats to ensure it isn't exploited.

No. 1: No purchaser may invest more than $100.

No. 2: The aggregate offering is limited to $100,000 maximum.

No. 3: Offerors must be individuals. Offerors may not be entities and must be United States citizens or legal residents.

No. 4: No offeror may have more than one offering open at any time.

No. 5: All offering materials and communications must contain a disclaimer clearly stating the possibility of total loss of the investment and the necessity of careful evaluation of each offeror's trustworthiness by the individual purchaser.

The letter also includes detailed descriptions of the benefits Kassan expects to see as justification.

"It's a totally crazy long-shot," she said. "Especially in this environment. Unfortunately, a lot of really bad players have made people really nervous about doing anything that would loosen up the rules at all.

"We wouldn't do it if we didn't think there wasn't a chance," Kassan added. "It's a very reasonable request."

Even if Ringlemann and IndieGogo didn't stand to benefit from the potential exemption, she said she'd support it. One of the things that drove her to start IndieGogo was being the child of small business owners and watching them refinance their house and cover business expenses with credit cards for 30 years.

"Ever year, 7 million ventures start," said Ringlemann. The average outlay is $45,000. But the average need is only $4,500. Most businesses are something like a hot dog cart. So people are financing it themselves with credit cards. If there was an easy way for people to raise 10 grand, then that could be the bread and butter of America.

According to Ringlemann, Kassan and Spinrad, a SEC exemption on small-scale investments is that way.

"There are two ways to protect people," Ringlemann said. "Require companies to do risk disclosure or cap investments. Second [option] wasn't used in 1933 because it was too hard to track. The Internet has changed that. So the question becomes what is the appropriate level? $100? $1,000?"

Spinrad, the arts enthusiast, sits at the $100-end of the spectrum. Investors and financiers are pushing for a larger, and therefore potentially profitable, cap.

But even if all the legal minutiae is resolved, there's still the question of why anyone would fork over their hard-earned $20 to someone else's crazy idea rather than their own.

For Megan Egbert, a Boise librarian, it started out as helping her friend Gregory Bayne with his film Driven.

"The platform allows someone not only to ask for money, but to show what they're doing," she said. "Plus, it makes it not awkward if you want to refuse."

Bayne campaigned to fund his soon-to-be-released documentary about mixed-martial arts fighter Jens Pulver getting ready for his underdog shot at the big-time. His effort has been used as a model of how to use crowdfunding.

Bayne first tried to raise money the traditional way, but he started running out of time before Pulver's main event. So Bayne made a trailer and put it on Youtube.

The trailer got more than 10,000 views in one week, which proved there was an audience, so he decided to try crowdfunding. His goal was $25,000 in 20 days, but he ended up with $27,000 and a fanbase itching to see the film.

Bayne was also able to use the contributors as a test audience, sending out clips and rough cuts to see how people responded.

After contributing to Driven, Egbert became curious and looked for other causes to support, giving to several including Travis Swartz's film.

"I wouldn't give money to someone if I had doubts about it. I've donated pretty small amounts to people, so if someone takes my $25 and runs I'm not going to be that worried about it," she said.

Paul Carew, another Boisean who contributed to Bayne and Swartz had similar sentiments. He was friends with both of them, but he also appreciated the efficiency of the process.

"I'm a business owner and a very busy person," said Carew. "In the situations where I used Kickstarter, it was a gut decision, and I knew I could plug in a credit card in 30 seconds and be done with it."

While the ease of donating to a project is attractive to donors, it's also drawing the attention of established organizations, which see it as a way to reach out to a new funding pool. Boise Contemporary Theater's Artistic Director Matthew Cameron Clark said in an age of declining corporate contributions, The Krumblin Foundation wouldn't have been possible without the campaign.

"New work costs more," he said. "Time for development, commissioning, fees, etc. We had to find new way to fund additional expenses."

Those new ways were to offer gifts ranging from free drinks to signed scripts to donors' names being written into the script (only $1,000 or more). The campaign was so well received that BCT raised $12,645 from 178 backers.

Still, crowdfunding isn't always the answer.

After only a few weeks, Swartz decided to cancel his Kickstarter campaign to fund Nobody Cares.

"With Kickstarter, I found I was spending my pre-production time being a fundraiser as opposed to being a filmmaker," Swartz said. "I think if I'd done it earlier and had a different plan for it, it would have worked out well. But I started a bit late, and I ended up spending exponential time on it because you have to hit that goal by a certain date."

Instead, he set up a PayPal account on his own website that people could use to contribute, and found a partner who took care of many of the equipment costs, making it possible to start production. Swartz wrapped shooting in early October and is in the months-long editing process.

To complete the project, he said he will need to continue raising funds, and though contributions have trickled off since the initial push, Swartz feels it will pick up again once he's cut enough of the film to show people what they're paying for.

"[Contributing] seems more a reaction to how much energy people see you putting into the project," Swartz said. "When they see that you have something, as opposed to the promise that you might have something, it has more impact."

At last report, Swartz had raised $3,100, far short of his initial goal of $25,000. But he's not concerned.

"I'm shooting the movie," he said. "That's the most important part."
To Learn More Click Here
Bookmark and Share

No comments:

Post a Comment