Imagine you have an idea you want to get off the ground. Maybe it’s a children’s book you want to write and need to pay for illustration, layout or cover design. Maybe it’s an animated short film that’s burning a hole in your head. You could max out your credit cards and put all your chips on you. Or, you could ask for help from people who want to be a part of what you are doing.

“Crowdfunding” – sometimes written as “crowd funding” – is the term that describes the pooling of money and other resources by a group of people to accomplish a goal or support an effort. In a very general sense, lots of things could fit into this category, including buying stock in a company. But, there are some important legal distinctions that have to be made that differentiate crowdfunding from offering shares in a company. We’ll get to those in a bit. First let’s take a look at a couple of examples of crowdfunding and see how the Internet has changed the entire concept.

Recently, we told you about New Perspectives Café, a startup company that will launch 30 stores on the same day, all via crowdfunded contributions by “members”.

From the New Perspectives website:

New Perspectives Cafe is offering people a chance to take part in a never before seen event. We are opening thirty stores on the same day in a simultaneous opening event. Here is the thing, these are not regular restuarants. These restaurant’s menus, events, and just about every decision you could care about, are controlled by you. When you become a member, not only do you get a ton of cool prizes, discounts, and lasting recognition and memories through our nostalgia wall, but, you also get to vote on how our store is ran. Beyond a very basic menu, you get to decide what exotic foods make and stay on the menu. You get to decide what theme nights and events occur. And, you get to decide what fundraisers we run and support. Come see what we are about. Purchase a membership and enjoy the fun and rewards we have to offer. The entry period for membership purchases begins on February 24th, 2012 and ends March 16th 2012. Store openings will be a date and time synchronized event occurring on April the 16th at 8pm Eastern time, 7pm Central time, 6pm Mountain time, and 5pm Pacific time.

Note what kinds of rewards there are for participating in the launch of these 30 cafés. Input on the extended menu, discounts, events, recognition on the nostalgia wall, etc. No monetary return on investment. That’s important, in a very legally-binding sense. Again, more on that in a bit. Let’s look at an example that goes back before a website like New Perspectives has was even possible. Set the Wayback Machine for 1997…

Marillion is a British rock band that has recorded sixteen albums since 1979, with two different lead singers. Their best-known song is “Kayleigh”, which peaked at number two in the UK and cracked the Top 100 in the U.S. in 1985. The song was so popular at the time that there was a huge spike in the number of girls who were given the name in the UK.

Although Marillion is still a well-known band in the UK, and the song “Kayleigh” was even used in the soundtrack for the video game Grand Theft Auto IV, Marillion’s presence in the U.S. has been diminished for a while. But, there is still a very loyal fan base, known as “Freaks“, in the U.S. In 1997, in a pre-Web example of crowdfunding, those fans financed a U.S. tour for the band.

U.S. fan Ryan Spaight explains how it happened:

Back in 1997, the band were mounting a tour for their first “independent” album after their contract with EMI ran out. It is very expensive for a band from the UK to tour America, between shipping people and equipment around and the normal financial hardships of touring. To do so without the support of a major label is even more difficult. To complicate matters, the band had never been as popular here as in Europe, where they were a top act for many years and still were fairly well-known at this point.

So the band announced that they would not be touring the US. US fans weren’t at all happy with this, obviously, and after some time a few fans on the “Freaks” e-mail list (which of course, along with Usenet, was the primary method for internet fan interaction back at that time) hit upon the idea of using the list to raise money to make a US tour financially feasible.

Tthe band was uncomfortable with it at the start. But once it became clear it wasn’t going to fizzle out, they accepted it and promised that if the effort was successful a CD recorded at one of the US shows would be sent to everyone who contributed $20 or more to the fund. Even then, the fund was administered by fans, not by the band.

The “Tour Fund” met and exceeded its goal and the US tour went forward. There was a special afternoon before the show in Pittsburgh for fund donors where the band played a mini-set, answered questions, signed stuff, etc.

While this would be the last fan-funded tour that Marillion would need to do, they have continued to use that crowdfunding model for future album releases. In the simplest sense, they pre-sold albums, but with a special twist. For fans that pre-order, and thus help fund the recording of, the album, the band issues a deluxe edition of the disc that includes all the names of those fans.

Natalie Cummins, another U.S. fan talks about funding one of the band’s albums:

In the case of Anoraknophobia, I got my name printed in the CD booklet. It’s tiny (there are LOTS of names), but it’s there! I felt good about contributing and then getting updates on the recording process. Then, when I got the disc, it really was a bit thrilling to see my name in there. Plus, you realize from looking at the sheer volume of names that you’re not the only one who really likes this band, and that’s a good feeling, too.

Ryan Spaight thinks that this kind of involvement of the fans with the band is based on trust, and has advantages to even established bands.

Most fans seem happy to do it if there has been a level of trust built up over the years — the fans trust that the band will follow through and produce a good album. Marillion have shown they take the responsibility seriously. They were also able to get the albums into stores via traditional labels (even EMI in some instances) since the cost to the label was minimal. But, the advantages of funding the recording this way are not having to go into debt to a label to fund the recording process, having total creative freedom, and owning the recordings at the end of the day.

This kind of funding could be a huge boon for bands that audiences would enjoy, or even have an established fan base, but who don’t fit into the current notion of what labels are looking for. As Natalie Cummins puts it:

It’s a solid funding model that’s been used by various artists of all persuasions, and I do think it helps get bands out there who might not be likely to get backing from a traditional label. It seems that the music industry has been slowly decentralizing for over a decade now, and these sorts of projects are vital to funding.

Again, notice that no fan who funded the 1997 tour or who has pre-funded the recording of albums is entitled to a “share” of profits. That isn’t because no one thought of it. It’s because it’s illegal.

All publicly-offered investments have to be filed with the appropriate regulatory agencies. In the U.S. that would be the Securities and Exchange Commission. The general guideline for whether an arrangement is considered a security that must be registered comes down to four points known as the Hoey Test. If there is (1) an exchange of money (2) with an expectation of profits arising (3) from a common enterprise (4) which depends solely on the efforts of a promoter or third party, then the resulting contract is a security. Most crowdfunding efforts that bring monetary returns to the investors would be subject to that regulation. Requiring all the regulation-watching, registrations, filing, and such puts offering remuneration out of reach for many people who have a small project they are trying to fund.

But, maybe that can change.

Back in November, 2011, the U.S. House of Representatives passed the Entrepreneur Access to Capital Act [HR 2930 – pdf]. The provisions of this bill would lift much of the stifling regulation currently in place for concerns that do not raise over $1 million, limit individual investments to $10,000, and demonstrate that investors know the risks they are taking.

Trouble is, that bill is stuck in the Senate. Forbes magazine did an excellent breakdown on the particulars of the arguments for and against the current form of the bill. For example, the Senate version, called the Democratizing Access to Capital Act, [S.1791 – pdf] limits contributions to $1,000 per person. But, many people, including the President, do think that this kind of loosening of regulations on small businesses and individuals could stimulate job growth and investment at at time that it is sorely needed. President Obama has promised to sign the bill if it can get to his desk.

One of the better-known ways that small projects bring their funding needs to the “crowd” is through websites like Kickstarter. The site is particularly focused on creative projects like books, films, albums, etc. They do impose certain house rules on those who attempt to fund a project through their site. For example the project must fully meet its funding goal before any money changes hands.

Another such site is Rockethub, which supports “entrepreneurs, actors, artists, composers, dancers, designers, directors, filmmakers, inventors, musicians, painters, philanthropists, poets, politicians, programmers, singers, songwriters, teachers, writers, and more.”

According to Rockethub’s rules, in order to be legal, offering the following as remuneration is not allowed:

* Equity (aka ownership)
* Revenue share
* Investment opportunities
* Entrance into lotteries, raffles, or sweepstakes.

If the Senate sees fit to pass the bill in either form, it could be a game-changer for artists, entrepreneurs, app developers and others who don’t need a whole lot, just enough to get their project off the ground, and are willing to share the spoils with those who help them get there.