Recent trends indicate a dramatic increase in crowd fundraising, as well as crowdsourcing, amongst startups and entrepreneurs. Crowdfunding in particular received a significant boost from President Obama’s JOBS Act; and the returns from crowdsourcing have increased dramatically with new advances in technology and open-source software.
Both crowdfunding and crowdsourcing use mass collaboration to achieve business goals. Essentially, both processes involve tapping into a large group of the public–a group rich in talent and/or capital–to fuel growth, innovation, and efficiency. Although they are similar in this respect, crowdfunding and crowdsourcing are two very different tools, with different legal implications, and the distinction between the two is therefore critical.
The difference between crowdfunding and crowdsourcing can be summarized in one sentence: crowdfunding entails sourcing funds from a large and remote online crowd, whilst crowdsourcing entails sourcing services, products, ideas, designs, etc., from that crowd. This article looks at each of these tools in more detail.
What is Crowd Fundraising?
Crowdfunding is a rapidly growing source of initial capital for startups. It is the practice of funding a business venture (or, in many cases, a private project) in the form of small amounts of money from large crowds of people online.
The crowd fundraising strategy emerged after the 2008 financial crisis, when small new business ventures faced substantial barriers to funding opportunities. Since then, the market has exploded, amounting to more than a billion dollar industry in 2017 (and that is only in the US). The explosion of financing through initial coin offerings (ICO) is an example of a specialized form of crowdfunding, for example. The explosion of financing through initial coin offerings (ICO) is an example of a specialized form of crowdfunding, for example.
Before 2012, crowdfunding was only possible as a way of acquiring donations or loans online. However, the JOBS Act legalized retail investment crowdfunding in 2012. This means that startups can raise investment funds online (essentially, raise capital in exchange for stock) because the Act allows for a narrow exemption to the Securities Act of 1933.
This development has two important implications: the potential for crowd fundraising is significant, but so are the legal implications. More on that below.
Crowdsourcing is a way of utilizing the expertise and talent of the crowd via the internet to obtain goods and services. Technological advancements have made it possible for diverse individuals from all over the world to contribute (with ideas, time, or expertise) to a collective project or cause. Crowdsourcing can be thought of as collective mobilization: it has the potential to transform the way a startup works, hires, researches, produces and markets.
There are a few important benefits to crowdsourcing as an approach to developing and growing your business:
Broad access to a flexible and diverse workforce
Improved business capabilities
Lower employment law liabilities
Some inspiring examples of crowdsourcing websites and tools include:
Waze: this revolutionary app crowdsources information by measuring drivers’ speeds, and allowing drivers to report traffic jams, accidents, or anything else.
Lego: The toy company allows users to design new products. This offers a great draw for customers, and it also helps the company test demand.
Samsung: In partnership with Marbler, a product development platform, Samsung crowdsourced ideas on how to utilize newly discovered patents from NASA in 2013. Users had the opportunity to create the company’s next product, and earn a share of the revenue in the process.
The Legal Implications
There are significant benefits to both crowdsourcing and crowdfunding. The two practices are closely related, and are often talked about as if they are the same thing. However, the difference between crowdsourcing and crowdfunding becomes critically important when we consider the legal implications of each.
From a legal perspective, there are a few issues to keep in mind when considering a crowd fundraising strategy in which you aim to offer equity in exchange for capital:
Businesses that are not incorporated in the US, investment companies such as mutual funds, and public companies may not raise funds through crowdfunding.
In certain circumstances, the Securities and Exchange Commission (SEC) might require extensive due diligence from the crowdfunding firm.
All crowdfunding transactions are required to take place online through an SEC-registered intermediary.
There is a legal maximum to the amount that may be raised through crowdfunding offerings in a year: $1,070,000.
There might also be a limit on the amount of individual investors that can invest in a crowdfunding offering in a year.
There are very specific disclosure requirements that must be complied with in the case of crowdfunding offerings.
Every crowdfunding agreement is based on a contract, many of these are standard terms and agreements set up by the crowdfunding intermediary. It is important to have a clear view of the contractual terms of such transactions.
Crowdsourcing does not have all the legal difficulties associated with the Securities Act. That does not mean that there are no legal concerns to be aware of. The most important of these are:
Intellectual property rights: If you use the services of an employee or a contractor, you will usually have concluded a contract with them that includes a standard intellectual property assignment clause. This gives you the property rights to any inventions, original works, trade or service marks, etc. that result from their work. When crowdsourcing, this assignment of rights does not necessarily take place. This could significantly harm your intellectual property portfolio.
Contract and tort liability: In order to hold someone liable for damages that you suffered, either in contract or tort, you have to prove some negligence with regard to a legal duty on their side. In the case of a remote contributor in the crowdsourcing context, your rights to claim for damages suffered due to negligence on that party’s side is not clearly set out, and not obviously protected in all cases.
These concerns are often addressed by the terms of service agreements on the websites or platforms used for crowdsourcing and crowdfunding. However, it is important to do your own due diligence and limit your legal risk before making use of services, goods, or funds from the virtual crowd.
As you can see, starting a crowdfunding and crowdsourcing campaign sparks a myriad of legal questions. As with anything legal related, it’s important to make sure you’re protected beforehand, rather than trying to play catch-up if something goes wrong. Startups routinely turn to us at LawTrades for quick and comprehensive legal help that won’t break the bank.