While crowdfunding has gained popularity over the past decade, it is not an entirely new concept. Crowdfunding got its start as part of the entertainment industry but has become a popular way for independent creators to kickstart their ideas. It’s no surprise that Kickstarter is one of the most prevalent crowdfunding sites out there. But what is crowdfunding, and why should small business owners be cautious about allowing the internet to fund their next project?

What is Crowdfunding?

At its base, crowdfunding allows interested parties to donate to a project or idea, with the main return is seeing the project completed. While some creators offer token gifts such as stickers or a finished copy of a book as a reward for different donations, many people donate simply to have their name on the project somewhere. Online Kickstart campaigns have been used for everything from crowdfunding TV shows to creating a full business in the case of a New Jersey crab shack and are appealing ways for small creators to get their projects off the ground.

Another, less prevalent form of crowdfunding is peer-to-peer lending (P2P), which allows people to get loans from other interested individuals. Unlike Kickstarter, P2P includes interest rates and is fronted through businesses like Prosper.com.

What to Watch Out For

Before you get your hopes up, there are some concerns with this kind of business lending. As with any kind of new financial industry, sometimes local and federal laws are not structured around the lending form, and as a result, your business may fall into a gray area as far as legality is concerned. The Securities and Exchange Commission (SEC) influences how securities are sold to the public in the United States, and companies must be approved by the SEC for businesses to receive payback from their investments.

As with any form of equity investing, investors are looking to influence small businesses, and this can result in shareholder meetings and investors influencing how the businesses are run. Not only does this take control of the business away from small business owners, but it can also strain resources and leave your business overwhelmed by investors.

In the case of online crowdfunding, while some projects receive incredible support, some never get off the ground, or creators realize they cannot rely on crowdfunding for their future projects. This can lead to issues finding reliable funding for other projects.

Keep in mind, investing is surrounded by laws and regulations for a reason. Investors and business owners both want their interests protected, and areas that have not been fully regulated or legislated can pose unknown threats to both parties.

Bottom line: it’s best to do your research before committing to crowdfunding options, and be aware of the threat to both your intellectual property and your business should you find yourself in an unsavory legal position or beholden to investors.

If you are looking to learn more about the best investment capital options for small businesses, or are looking to learn more about the legal history of investing, check out some of the other incredible Capital Finance Partners blog posts available here.