4 Crowdfunding Cautions for Small Businesses

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NEW YORK ( TheStreet) -- Small companies will soon have a new option to obtain financing through crowdfunding, but there are some cautions to consider.

The so-called crowdfunding term essentially means pooling resources or money together from a group. Under the Jumpstart Our Business Startups Act, or JOBS Act, small companies will have the ability to raise up to $1 million in equity on an annual basis through crowdfunding, without having to go through the rigorous disclosure process by the Securities and Exchange Commission .

To be sure there are a host of unknown answers regarding crowdfunding, but as more companies take to social media to tell their story and gain a following, the strategy could become a major player in the alternative financing sector.

Right now, crowdfunding is a popular tool for charities, artists, theaters and other organizations that essentially want donations. Through crowdfunding followers can show support, contribute and get behind an idea, but it's not actually an investment.

"To put that platform in the hand of business owners and allow them to be creative and allow them to tap local friends and family is just incredible news," says Lendio CEO Brock Blake.

Two often-cited crowdfunding sites are Kickstarter and Indiegogo. But the new law should open the marketplace for many more crowdfunding sites to be launched. It will also open the door to potential risks.

Already early crowdfunding backers are launching a self-regulatory organization to essentially act as a gatekeeper to accredited crowdfunding sites.

The Crowdfunded Intermediary Regulatory Association seeks to provide "investor protection and market integrity through effective and efficient regulation of those within the crowdfunding industry," it said in a press release last week.

"This is a great opportunity for many businesses that are ready to 'take that step,' such as those companies that are geographically at a disadvantage or not in proximity to venture capital firms," says Karen Kerrigan, president and CEO of the Small Business & Entrepreneurship Council. However, "businesses might be reading about this and hearing about this and saying 'Oh wow this is a ticket to the funding I have been looking for,' but there is a reality check here on these crowdfunding platforms you're going to have very tough audiences, in terms of investors."

On a positive note, companies and their owners will likely learn "what they need to do in order to raise capital," Kerrigan says.

"You have to be ready to go on these platforms in terms of disclosing financials. You also have got to have your act together in business plan viability in the marketplace. There are a lot of things that you're going to have to disclose and share to these investors. You can't expect to just throw something out there and say ... fund me," Kerrigan says.