K
  • March Article: Accounting 150

    Dr. Bruce Kuhlman, CFA, CAIA, Full-Time Faculty, Kaplan University 
    Published March 2014

    What would you do if you and a few of your close friends felt you had just filmed the next Blair Witch Project1 but you didn’t have enough money to promote your film at the Sundance Film Festival?2 Would you ask your family for the money? Would you go to a bank and try to get a loan? Alternatively, you could try listing your film project on a crowd funding site on the Internet.3 One site you could use is Kickstarter, which is mostly dedicated to facilitating the funding of artistic endeavors.

    According to their website, since 2009, Kickstarter has facilitated the successful completion of over 55,000 projects. Using Kickstarter, project creators, all innovators like you, determine the amount of funding they need and the date by which they need it. Interested individuals search the Kickstarter website and pledge money to projects they like. If enough money is pledged to your project, your project moves forward!

    Here’s the best part. People who contribute to projects on Kickstarter do so for philanthropic reasons. They are not interested in financial gain; they want to be associated with your project. If you get your film to Sundance, perhaps you will provide them with front row seats to the first showing. Maybe you’ll even put their names in the film’s credits!

    What Is Crowd Funding? 

    Crowd funding is many individuals (i.e., a crowd) pooling their money together to fund the endeavors of an individual, organization, or firm. Raising sufficient funds depends on the ability to utilize available media to get the idea out to the crowd. In the past, choices included the telephone, “snail” mail, newspaper advertising, etc. Crowd funding was typically limited to community organizations with a natural following. For example, a community could pool intellectual and financial resources to fund a new playground.

    Today there are many crowd funding facilitators on the Internet,3 so entrepreneurs can quickly and easily present their business proposals to literally millions of potential investors. Investors pledging money on these sites receive equity or debt claims or, as in the case of Kickstarter, “help bring creative projects to life” just so they can say they were part of it all. EquityNet and other crowd funding intermediaries on the Internet help investors raise equity capital.

    Entrepreneurs and business owners display their projects on these sites along with considerable financial and operating data and projections. Contributors on EquityNet and similar sites truly are investors, in the sense that they receive an ownership claim proportional to the amount invested in the project. Of course, crowd funding equity investors share in the success or failure of the project, just as with any other equity investment.

    Is Crowd Funding All Good? 

    The best part of crowd funding, from the perspective of the entrepreneur, is the seemingly unlimited number of potential investors. As long as you can present enough enticing information about your proposed project, you will most likely find individuals willing to invest with you.

    Next, the offering does not require registration with the Securities and Exchange Commission (SEC),4 and investing is not limited to accredited investors. That is, neither you nor your investor has to qualify in any way.

    Of course, the simplicity and efficiency of crowd funding through the Internet has a few drawbacks. With the ability to post virtually any project and the ability to circumvent U.S. securities laws comes the real possibility for fraud and abuse. For example, how can investors be sure that you really do have a great film project? Are they truly able to assess the risk of your project by reading what you have posted on the Internet? How can donors be sure that a philanthropic website is real? Could Internet crowd funding become just another form of Internet gambling?

    In response to the proliferation of Internet crowd funding sites, the SEC has proposed a lengthy set of rules for crowd funding. Even though the new rules fall short of requiring SEC registration, they would, among other things:

    • Prohibit some companies from raising capital through crowd funding.
    • Place maximums on amounts raised through crowd funding.
    • Limit individual investments.
    • Restrict the resale of the securities.
    • Allow only SEC-registered intermediaries (Internet sites).
    • Require financial statements prepared in accordance with U.S. GAAP.

    Readers familiar with the rules and regulations associated with the public offering of securities in the United States will recognize many similarities. Basically, through this document the SEC demonstrates that it recognizes the potential for fraud and other abuses.

    Accounting Opportunities 

    The requirements proposed by the SEC place accounting requirements on crowd funding issuers,6 which in turn present opportunities for accountants. Tysiac7 describes the SEC’s proposed rules for accounting for crowd funding, which are based on the size of the offering:

    • For offerings of $100,000 or less, the principal executive officer must certify the financial statements and provide the SEC with income tax returns for the most recently completed fiscal year.
    • For offerings greater than $100,000 and less than $500,000, an independent accountant must review the financial statements.
    • For offerings greater than $500,000, an independent auditor must audit the financial statements.

    Conclusion 

    In its most basic definition, crowd funding is simply the accumulation of the contributions of many (i.e., the crowd) to facilitate the successful completion of some project. Rather than a small set of creative entrepreneurs bearing all the financial risk, any risk associated with the project is effectively spread across many contributors.

    The modern form of crowd funding, facilitated by the Internet, has become something else. True, the risk of the project is still spread out across many investors, but the proliferation of Internet crowd funding intermediaries and the multitude of potential projects has driven crowd funding to mind-boggling dimensions. Today interested parties can find literally thousands of crowd funding projects through the click of a mouse.

    End Notes 

    1 “The Blair Witch Project” was an independent film that was written, directed, produced, and filmed by five University of Central Florida graduates. It was released in July of 1999 and grossed over $240 million. For more information see www.blairwitch.com.

    2 Italicized words and phrases are defined in the Definitions section.

    3 Internet sites that facilitate crowd funding are known as intermediaries.

    4 Certain public issues of securities must first be registered with the SEC. Exemptions from SEC registration include private offerings to a limited number of persons or institutions; offerings of limited size; intrastate offerings; and securities of municipal, state, and federal governments. See www.sec.gov for more information.

    5   To invest in most private equity funds, hedge funds, etc., the investor must qualify as an accredited investor. To qualify as an accredited investor an individual must have net worth exceeding $1 million or income exceeding $200,000 in each of the two most recent years and a reasonable expectation of the same income level in the current year. See www.sec.gov for more information.

    6 A crowd funding issuer is the individual or firm seeking the funds. Investors receive equity shares issued by the crowd funding issuer.

    7 Tysiac, K. New Opportunities for CPAs in Proposed Crowd Funding Rules. Journal of Accountancy, October, 2013.

    Related Internet Sites 

    • For an example of a crowd funding intermediary that facilitates equity (ownership) investments, see www.equitynet.com.
    • For information on the securities registration process in the United States, see www.sec.gov.
    • Just for fun, Google crowd funding. You will be amazed at the number of hits!

     

    Bruce Kuhlman is a full-time faculty member at Kaplan University. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University. 

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