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Equity Crowdfunding for Art is Finally Here.

Ex-Best

Crowdfunding is an amazing way to get art projects funded, but an aspect that has been lacking is the ability to invest in art projects or the companies developing those projects. Recently, after years of discussion around the topic, Indiegogo announced that it will be offering equity crowdfunding to its customers, which includes opportunities to invest in companies or give companies loans rather than just the ability to donate funds. Before we discuss how this new approach could benefit small art businesses and artist projects, let’s look at traditional donation crowdfunding, pioneered by companies like Kickstarter and Indiegogo, and then compare it to the investment model.

Today’s crowdfunding sites have hundreds of art projects with each project using its limited resources to generate buzz and attention.  The hope is that enough people will be so enamored with the project that they will be willing to donate their hard-earned income to see the project come to fruition.  Take the new web series, Ex-Best (www.ex-best.com), created by Monica Hewes and Diana Gettingerwhich launched its first season this week after raising financing on Kickstarter.  Ex-Best is about the trials and tribulations surrounding two female friends who break up with each other. It is a clever series centered around a topic that many people have experienced at some point in their lives.  Plus, Ex-Best is a project made exclusively by women filmmakers in an industry that has been hammered recently over the apparent inequities between men and women in the workplace.  So, it was the perfect vehicle for the traditional crowdfunding model. Ex-Best found a devoted audience and through a well executed social media campaign is now available for everyone to enjoy.

The issue for Ex-Best and art projects just like it is what comes next?  If Hewes and Gettinger are lucky, the series will get picked up for distribution with future seasons funded by a studio or a distributor.  Unfortunately, while the series has been highly rated and generating an industry buzz, quality and talent does not guarantee anything in Hollywood.  (Just think of all the excellent TV shows that never made it to season 2.)  So let’s assume for a moment that despite the series success, Ex-Best doesn’t get picked up by a studio or distributor and must seek out funding for a second season. What options will Hewes and Gettinger have?  One approach is to jump on Kickstarter again, using the same process as they did before, although this time they have a target audience they can call on for donations, namely the people who downloaded the series as well as those people that helped fund season 1. Name recognition may also help reach potential donators.  However, season 2 may require a larger budget as members of the team who donated their time on season 1 may now be looking for a paycheck.  With a higher budget, that funding goal may be harder to reach.

If they don’t reach their objective, Hewes and Gettinger can always approach wealthy individual investors that could fund the project in return for a portion of the revenue generated. Individual investors are hard to find and usually want a substantial return on their investment. Another opportunity is to look for money from a venture capital (VC) firm. VC’s aren’t generally interested in funding projects but might be interested in funding a production company intent on producing more than just a single web series. They will review dozens of companies, each one going through an extensive vetting process.  In the end, only a few will get a funding deal, and those deals are very favorable to the investor.  For example, investors almost always want controlling shares, which allow them to control the company and dictate creative and marketing direction.  While they tend not to interfere when expectations are being met, they will insinuate themselves into the day to day operations if financial projections fall short. When non-creative people dictate creative direction usually means disaster.

Investors also have a tendency to underfund projects, slashing costs before the project even begins.  For example, let’s say Ex-Best needs $100 for season 2, investors will probably only give $80, requiring Hewes and Gettinger to offer lower salaries, or cut back on location shoots, scale back marketing efforts, or even shorten the number of episodes. It’s difficult, demoralizing and takes a toll on any production.  Why do they do this?  Investors assume that those receiving funding are not as frugal since it is not their money and so there is always fat that can be trimmed away.  Unfortunately, that is not always the case leaving many projects or companies underfunded, which can have a detrimental effect.

Without a guaranteed way to get funding and resources for a project, many are stopped dead in their tracks.

Equity Crowdfunding to the Rescue

Equity crowdfunding allows many individuals to invest in a project rather than one large investor. Like a traditional stock investment, each investor buys shares in the project.  A successful project generates revenue, increases its value, which in turn increases the share price. In debt crowdfunding, the investment is not for shares but is a loan with a fixed repayment term, along with a specified interest rate during the term of the loan. Debt crowdfunding’s fixed return makes it easier for financial planning purposes and is seen as less risky since it is secured against assets, which is anything purchased or donated to complete the project. More importantly, control remains with the project team.  If things go bad, the shares may lose value but no single investor has the power to interfere with management’s decisions.

Equity CrowdfundingProponents of the equity approach often point to the Oculus Rift debacle that occurred a few years ago.  Oculus Rift is a virtual reality system that became the darling of computer geeks everywhere. Not only did the company raise over $2 million from 9,500 backers on Kickstarter, but programmers from around the world donated time to help develop the system because the system was supposed to be “Open Source,” not corporate controlled.  People wanted Oculus Rift to succeed, so programmers participated in its development and backers donated money to see it come to life.  Then, much to the outrage of supporters, Oculus Rift sold the company to Facebook for $2 billion.  Had the backers been allowed to invest rather than merely donate money, they would have seen close to a 1,000 percent return. Instead, Facebook controls the technology.

Of course, the donation approach is more than adequate most of the time, but there are certainly situations where people would be more apt to give money if it were an investment rather than a donation.  For example, let’s continue with our Ex-Best hypothetical story and assume Ex-Best needs significantly more funding for Season 2 and the donation goal fell short but with the potential revenue, thy could easily implement an equity approach.  Given the success of the first season, Hewes and Gettinger could probably cut better deals with advertisers for commercials and product placement. They can also sell merchandise, or develop a VIP pay site with exclusive content.  From Hewes and Gettinger’s perspective, they would have to give away some of those profits to the Kickstarter investors but they would still maintain the bulk of the revenue. There is no requirement that the investors make back their investment either.  The important thing is that they can get their show made, paying the team decent salaries, pay for equipment or location shoots, only repaying investors out of what is left over.  More importantly, none of the investors can interfere with the project’s production or any other strategic decisions.

From the funders’ perspective, they are no longer merely donating to the project but have an opportunity to generate income or at last get their donation back.  They also have a vested interest in Ex-Best Season 2’s success. As such, they are likely to promote the series amongst their friends and through social media.  Every extra Facebook, Twitter or Instagram post helps make the show a success.  Plus, if equity investment drives higher funding as proponents of the equity crowdfunding model suggest, then Ex-Best will have additional money for marketing and PR that could potentially generate even more revenue, which will offset money paid out to investors.

Why has Equity Crowdfunding Been So Hard to Implement?

Equity crowdfunding may seem like a no-brainer, but unfortunately, government regulations have made implementation difficult.  The Federal Government has had rules over the sale of securities for a long time.  In the U.S. securities are regulated by the Securities and Exchange Commission (SEC).  Until recently, SEC regulation only allowed high net worth individuals or companies to invest in startups. That may seem unfair, but the regulation had a seemingly benevolent intent: to protect unsophisticated investors from getting defrauded. While public companies are bound by strict disclosure rules about their corporate structure and finances; private companies have no such disclosures.  It would be very easy for scammers to take the money and run.  For low net worth individuals, this would be disastrous, likely driving those investors to need government assistance. On the other hand, high net worth individuals could survive the losses just as venture capital firms would.  Both mitigate their potential losses by investing in dozens of different companies with the successful businesses covering the losses on the losers. Inexperienced investors, or those with little money, don’t have the funds required to create a diversified investment portfolio to hedge their potential losses. 

However, with the passage of the Jumpstart Our Business Startups Act of 2012 (JOBS Act), anyone can invest in startups or crowdfunded projects.  As President Obama proclaimed; “For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.” Once all the kinks are worked out, equity crowdfunding could be revolutionary.  Under the JOBS Act, individuals with annual income or net worth of less than $100,000 would be limited to investments of $2,000 or 5% of their income or net worth, every 12 months. These caps alleviate the potential for investors to lose too much of their investment, even if the crowdfunded project is a scam. As well, Congress, in a surprising bit of wisdom, added additional disclosure requirements to the JOBS Act at the last minute, which require greater disclosures as the funding levels increase. The more funding received, the more disclosure required. GI FlyBike

Of course, equity Crowdfunding is only another tool and isn’t necessarily appropriate for all projects or companies.  Look at GI FlyBike, the only Electric Bicycle that can fold in seconds, which has four days left on its Kickstarter campaign, or Bevel, which turns your smartphone into a 3D Camera, now on preorder. Both significantly overshot their crowdfunding goals with Gi FlyBike receiving $408,000 so far of its $75,000 goal, and Bevel receiving over $300,000 for its Indiegogo campaign.  For these companies, giving away equity would have been a waste.  However, some projects, particularly art businesses, could benefit from small-time investors who are willing to risk a few thousand dollars or give some people the opportunity to support a business they admire with the potential to receive more than a t-shirt or baseball cap.

Still, the logistics involved in implementing equity crowdfunding is rather complicated. “Facilitating regulated investments is very different from giving away T-shirts or hats or putting people’s names in the credits of a movie,” says Ryan Feit, CEO of SeedInvest and co-founder of the Crowdfunding Professional Association. So, at this point, Sites like Indiegogo and Kickstarter are only getting their feet wet, weighing the potential revenue against the cost of implementing a system with significantly more regulations than they must currently follow.

Will equity crowdfunding become mainstream? It is too early to tell, but there is little doubt that even if big crowdfunding sites decide the equity model is too cumbersome, smaller crowdfunding groups will likely step in to fill the void.  Smaller companies will always look for a competitive advantage over their larger competitors, and equity crowdfunding could give them that advantage. We will have to wait and see how it all plays out, but it’s likely that equity crowdfunding will find its way into the mainstream giving projects like Ex-Best another avenue to receive the funding should they need it.

About the author

Steve Schlackman

As a photographer and Patent Attorney with a background in marketing, Steve has a unique perspective on art and law. Should you have any questions on Intellectual Property contact him at steve@orangenius.com. His photography can be seen online at Fotofilosophy.com or on display at the Emmanuel Fremin Gallery in New York City.

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