Crowdfunding's Wild West Awaits aStampede
Crowdfunding is now just asmall piece of thestartupfunding pie. Just wait. Animminent law change couldtransform the donate-to-my-cause-for-a-tote-bag industryinto a popular way for smallcompanies to raise the cash theyneed to grow.The legislation, whichCongress passed yesterday and awaits President
Obama’s promised signature, is expected to unleash a wave of
crowdfunding platforms, according to a crowdfunding industryorganization.
“There will be a significant
number of equity-based crowdfundingplatforms in the next years --
probably hundreds and hundreds,” says
Carl Esposti, the founder of the Los Angeles-based Crowdsourcing.org.
The crowdfunding provision was just one of several in theJOBS Act (named for the acronym for "Jumpstart Our Business Startups") aimed tomake it easier for small businesses to gain access to capital, grow andhire.
Crowdfunding is a way of raising money that involves securing smallsums from a large group of individuals. In recent years it has becomemore mainstream thanks to the likes of websites including Kickstarter,Indiegogo and Kiva.The soon-to-be law will allow entrepreneurs to raise money fromnonprofessional investors and give away equity stakes in exchange.Until now, crowdfunding has been used mostly to raise funds for artisticprojects. (Think: Record a music album.) Project leaders offer perks(perhaps a tote bag or autographed CD) in exchange for donations.Businesses have been able to "crowdfund" in exchange for equity, butonly among accredited investors (such as angels) with more than $1million in assets, excluding the value of a primary residence.
“It clearly has an enormous potential for new capital formation,” saysEsposti. “There is no doubt that it will create a new way for smaller organizations to raise capital very quickly and more cheaply.”
Going forward, crowdfunding sites will have a decision to make abouttheir structure. Those that want to allow businesses to raise money byselling equity to investors will have to register with the U.S. Securitiesand Exchange Commission. The SEC has 270 days from when thelegislation is signed to establish rules.San Francisco-based crowdfunder Indigogo is still deciding whether toregister, according to CEO and co-
founder Slava Rubin. “We need tomake sure this works for our customers,” he says. New York City
-basedKickstarter, the largest donation-based crowdfunding companyaccording to Crowdsourcing.org, declined to comment.
One small-business crowdfunder welcomes the expected surge in
competition. “The market is also expanding greatly at the same time,”
crowdfunding site based in Fayetteville, Ark. “All of the activity andcompetition serves only to validate the market, validate the model.”
One crowdfunding entrepreneur expects that all the new platforms won't
last. “Down the road, the large number of platforms that you see pop upwill thin out again,” said Candace Klein, founder and CEO of
SoMoLend,a small-business crowdfunding site based in Cincinnati,Ohio.The new law is also set to increase the pool of people who can invest insmall companies. Under the law, anyone will be able to invest incompanies, not just accredited investors. How much an investor can sink into a ven
ture will depend on the individual’s income and net assets,
according to the pending new law.
“You go from 2 million investors controlling a trillion dollars to now,
with the crowdfunding bill, to upwards of 50 million investorscontrolling upwards of $5 t
rillion,” says Hollas. “Even if they shifted a
minor percentage, that would be an incredible economic input into the
system.”
Concerns over investor protection voiced by the SEC, among others,reined in provisions of an earlier House version of the measure. Back inJune 2011, the SEC made clear its view of unregulated crowdfundingactivity. When Michael Migliozzi II, a 45-year-old California resident,and Brian William Flatow, a 41-year-old Connecticut resident, tried tocrowdfund the purchase of Pabst Brewing Co., they were shut down.The BuyABeerCompany.com website offered a portion of the companyin exchange for investment, in addition to some beer. Launched in
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