Cloud Funding Offers More Than Pennies From Heaven

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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In the age of social networking, if you need money for an art project or for a new business, friending could also mean funding.

Chris Young wanted to shoot a feature film presentation. The plot: dude's car breaks down in the desert, no mobile signal, not a soul in sight. Parched, our hero stumbles into a lonely gas station where he makes a disturbing discovery. Someone, or something, is chained to a backroom wall.

Bankers didn't get it, but peeps on Twitter, Facebook, and LinkedIn did. Within eight weeks people donated $11,350 (more than his goal) so Young could shoot the 3D live-action short. What did those 92 people receive in return? Depending on how much they contributed, Young's collaborators were given special mention in the credits, invited to the first screening and party, or announced in the main titles as Executive Producer.

Welcome to the world of cloud funding, also known as crowd source capital or social funding, where entrepreneurs combine social networking with project fundraising.

How It Works

Unlike peer-to-peer microlending, which was introduced to the U.S. in 2005 by Kiva, social funds aren't paid back. Unlike debt funding from banks, social funding doesn't require you to pledge collateral or offer personal guarantees. Unlike equity funding from venture investors, you don't have to give up equity or control.

Young used IndieGoGo to raise the money for his project, but other cloud funding websites exist. Kickstarter, Pledge Music and SellaBand focus on the arts, and Spot.Us helps support investigative journalists. IndieGoGo and Invested.in help a wide range of entrepreneurial effort from musicians, to writers, filmmakers, game or application developers, designers, inventors, non-profits, and charities.

IndiGoGo was launched in 2008 to leverage social marketing with view that it would democratize lending. And it has. Contributors from 120 countries have participated in more than 5,000 projects on IndieGoGo. The average fund raising goal is about $5,000, but projects range from $500 to $25,000.

The process is straightforward. You create an account, and website forms help you build a project description, establish fund-raising goals, and explain "perks" designed to entice people to contribute at various levels.

Some people will contribute simply because they like what you're doing, and projects with a video description raise 122% more, according to IndieGoGo. Other people will be attracted if you offer desirable perks. Contributions tend to be in the $50-$75 and $300-$400 range.

IndieGoGo makes money the old fashioned way; they get 9 percent of whatever you raise. But they add an innovative twist: If you meet your fundraising goal in the time you've set, they pay you back 5 percent. This offers you an incentive to market your project aggressively so the site has a better chance of making money. 4 percent of something is better than 9 percent of nothing, after all.

What If You Don't Make Your Goal?

Nevertheless, not all projects meet their fundraising goals. In any event, if your project is underfunded, you've still learned a valuable lesson. If you can't attract people to your project you know that either your project isn't attractive or your marketing isn't working. Good ideas are a dime a dozen, and most people will politely give you their two cents worth when asked for an opinion. But when it comes to dollars for dancers, say, they may not be as enthusiastic.

Surprisingly, if you don't reach your goal, you still keep the money you raise, less the websites' take. Even more surprisingly, according to Danae Ringelmann, President and co-founder of IndieGoGo, contributors understand they won't get their money back if the project isn't fully funded.

But if you get to keep the money, even if your project isn't fully funded, doesn't that attract people who dishonestly claim they have a project so they can to run off with the money? No, says Ringelmann, "People inherently don't have an itch to fund the unknown. (But) if a friend, blogger you like, or organization you're a part of funds a project and tells you about it, you're much more likely to fund it than if you stumbled upon it on your own."

According to Ringelmann, "The transparent and open nature of cloudfunding gives project champions the opportunity to showcase their growing community and the traction on their project — two key elements that not only build trust and spark a movement, but also provide validation that the project is legit. So projects that don't reveal who's behind them, don't have a core community, and don't do outreach to showcase the community building around it are very poor candidates for success. A person who wanted to commit fraud by raising money and running would have to be willing to destroy their reputation and social graph connections across the web to succeed."

Regulatory Issues

Federal and state laws govern debt and equity funding. Any investment opportunity that's offered to the general public, no matter how small, has to be registered at substantial expense with the Securities and Exchange Commission (SEC), for example. Technically, you can't even invest $10 in a project led by someone you know personally if they offer you a share of the profits from their venture.

But that may change thanks to social financing. A successful crowdfunding campaign raised $1,300 to cover the cost of preparing a petition to convince the SEC to exempt projects of $20,000 or less, and for contributions of $100 or less. If public response is strong enough, the SEC might just make the change — all thanks to the power of a crowd.

It's Not Just About The Money

Over a two-month period, 97 people contributed a total of $2,700 to help Elaine Zelker, a hospice nurse, produce a photography exhibit of her patient's hands for display in a local gallery. In return, her contributors received a big thank you, or — if they really dug deep — a coffee table book of the collection. That's all.

Zelker say, "I'd love to book more 'hand participants' and capture their last photo. Everyone has a unique story to tell. I am not able to leave my day job yet, and do photography full time. I am waiting for that moment."

That may happen. She's booked a half dozen photography jobs over the past three months. They may not have been a direct result of the exhibit project, she says, but now she knows people love her work. Social funding may have helped her take her photography to a new level.

Who needs pennies from heaven when you can find dollars in the cloud?