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Fund-Raising for the Facebook Generation

Crowd-funding sites help entrepreneurs kick-start their businesses, but are these new platforms too good to be true?



When Heather Sittig and Kristen Policy decided to open a new wine bar in Rockridge, they thought about how, in the old days, out on the frontier, whenever someone wanted to build something useful — say, a barn — the whole community would gather to raise it.

They started thinking: What if they could use that same approach to raise the money they needed to build out their kitchen and get their wine bar, Toast, off the ground? What if everyone they knew, or maybe everyone in the surrounding neighborhood, just chipped in a few dollars? After all, it's no secret that coming up with enough start-up capital is one of the biggest obstacles for any new business.

"We talked to the banks about small-business loans and that sort of thing," Sittig explained. "Basically, the lending environment right now is terrible ... and for restaurants, basically it's a non-starter. They won't lend on a start-up restaurant, period."

It was around this time that Sittig and her business partner learned about, probably the most well known among a growing number of "crowd-funding" web sites that provide a platform for small businesses and individuals to raise money for various projects. Combining the power of social networking with a do-it-yourself approach, Kickstarter and other similar sites have become enormously popular and powerful tools for alternative fund-raising. Rather than getting traditional investors to buy shares of stock in a company, crowd-funding sites allow individuals to make a more humble contribution of five or ten or maybe a few hundred dollars.

After signing up with Kickstarter, Sittig and Policy uploaded a video in which they talked about their dream of opening up a wine bar. To encourage individuals to pledge money at various levels, they offered perks that ranged from T-shirts to discounted wine vouchers to a "Founder's" title and priority seating for the life of the restaurant. In accordance with the rules of the site, they set a deadline by which they needed to reach their goal of $15,000. Then they sent out e-mails to their entire social network, letting everyone know about the fund-raising project.

In short, their campaign was a success. By the time their Kickstarter deadline rolled around, about two months later, Sittig and Policy had slightly exceeded the $15,000 target — in less than a quarter of the time it took for them to raise the same amount through a similar effort conducted on their own web site. Before Toast has even opened, they've already sold more than 2,000 glasses of wine and, Sittig said, they now essentially have a built-in customer base. All that's left to do is get that barn raised.

Toast's story is one that is increasingly common, both in the Bay Area and beyond, as crowd-funding platforms like Kickstarter become more popular. Kevin Lawton, the San Fransico-based co-author of The Crowdfunding Revolution, estimates that there are now as many as two hundred individual crowd-funding sites, many of them focused on highly specific niche markets. There are, for example, multiple crowd-funding sites for aspiring fashion designers. There are also crowd-funding sites for freelance journalists who want to report a research-intensive story but can't find a publication that will pay a decent fee for them to do so. Kickstarter and San Francisco-based IndieGoGo, another of the more popular sites, are multipurpose but tend to attract creative types — indie filmmakers, musicians, inventors, bakers.

But while aspiring entrepreneurs see these sites as a source of free money or, at the very least, a way to obtain a kind of "no-interest loan" (as Sittig described it), crowd-funding — like most aspects of starting a business — isn't without its risks. For starters, there are fairly significant fees to be paid once a project is successfully funded — typically between 5 and 10 percent of the amount raised once applicable credit card fees have been factored in. Because Kickstarter and many of the other sites use an "all-or-nothing" approach, it's also possible to put in several weeks of work and raise thousands of dollars, only to lose everything if you fall short of your goal. And even if you were to treat the crowd-funded cash as a sort of informal "loan," once you've spent the start-up capital to get your restaurant or cafe up and running, you're left to pay the debt back, one free glass of wine at a time, during that precarious first year of business, when the margin for error is razor-thin.

And then there's the question of whether crowd-funding, as it's currently practiced, is legally sustainable. So far, sites like Kickstarter have dodged the ire of the Securities and Exchange Commission by prohibiting those who donate from profiting on the transaction by, say, receiving shares of stock. That would be in clear violation of the SEC's ban on "general solicitation," which forbids the use of mass media, including the Internet, to advertise securities offerings. Nevertheless, in this burgeoning arena that's pushing the boundaries of what existing regulations could have ever foreseen, there's no shortage of legal issues — for the crowd-funding platforms themselves, as well as for their users.

There is, for example, no way to reliably ensure that those collecting donations are paying the appropriate taxes on them. There's also no clear mechanism on these sites for preventing fraud. Lawton says that while there haven't yet been reports of people taking donations and disappearing, the potential for that certainly exists, especially because there are dozens of independent crowd-funding sites with widely divergent levels of project-vetting and self-policing — all of them deficient, in his view. In fact, Lawton says, "You've got to imagine that it's only time before the regulators step in and squash a bunch of these guys. And they don't need a particularly great reason."