Higher Stakes for Crowdfunding


Crowdfunding is growing up, whether it’s ready or not. In recent years, online hubs like Kickstarter had already become more than venues where freethinkers seek money for whimsical ideas: The makers of the Pebble Smartwatch, for instance, used the site to raise more than $10 million, while in return, close to 69,000 donors got to preorder the watch at a discount. The one thing you weren’t been able to get from a crowdfunding site was an ownership stake in the venture you’re backing. That’s changing, as a U.S. law that can turn the crowdfunding field into a miniature stock exchange gets implemented. It’s a prospect that has would-be entrepreneurs and cash-strapped small businesses salivating, and some regulators nervous.

The Situation

In October 2015, the U.S. Securities and Exchange Commission approved rules to allow small investors buy shares in startups in much the same way they buy shares of GE or Wal-Mart. The rules came three years after President Barack Obama signed a bipartisan bill, the Jumpstart Our Business Startups (JOBS) Act, meant to allow businesses to raise as much as $1 million per year this way. People whose income or net worth is less than $100,000 are limited to investing a maximum of $5,000 annually. Investors with income and net worth of $100,000 or greater can contribute as much as 10 percent of their annual income or net worth, up to a maximum of $100,000 in one year. The restrictions are intended to limit the downside for shareholders who take stakes in riskier companies that provide less information to investors than public companies. While the SEC was working on the new rules for small investors, plenty was happening in other countries and at other income levels. In the U.S., wealthier investors have poured money into crowdfunded real-estate ventures; Sony has used Indiegogo to crowdfund an “inventor’s kit” (and get publicity) and Taiwan has made crowdfunding startups part of its strategy to keep a step ahead of China.  Crowdfunding also exists in the United Kingdom, but is heavily regulated.

Source: Bloomberg Rankings
Source: Bloomberg Rankings

The Background

The JOBS Act was promoted as a way to give the economy a boost by making it easier to start or expand and run a business. Entrepreneurs have historically struggled to raise money; banks have been notoriously stingy in lending to small businesses. Aside from friends and family, entrepreneurs have been limited to pitching what the SEC calls accredited investors, people with $1 million in net worth and annual incomes of $200,000 or more. Dealing with big fish like these was often a one-sided proposition for somebody trying to get her dream product out of the garage and into stores. The act also gives small investors a way to get in on small new companies outside of markets like penny stocks or microcaps, fields whose checkered history was illustrated in “The Wolf of Wall Street.”

The Argument

Securities rules exist to protect investors from themselves, and critics of crowdfunding worry that the new law puts unsophisticated shareholders at risk. Mercer Bullard, an associate professor at the University of Mississippi Law School, warned Congress that the law could make it “much easier for scam artists to sell unregistered securities.” The Act’s supporters say the old system has hurt U.S. competitiveness and slowed the economy’s recovery by making it too costly and inefficient for small businesses to raise money. A former chief SEC accountant, Lynn Turner, has said that leaving it up to investors to abide by the net worth requirements is “creating a real opportunity for scams and fraud and significant losses.” To limit that risk, some argue that background and regulatory checks should be required on company executives.  Sherwood Neiss, principal at consultant Crowdfund Capital Advisors, said that the self-verification system shows that the SEC understands “we are moving to this collaborative culture where we use technology to enable capital formation.”

The Reference Shelf

  • Massolution provides research and an industry outlook.
  • The University of California at Berkeley College of Engineering offers industry estimates and analysis of the JOBS Act.
  • Steve Case, the venture capitalist and co-founder of AOL, has been on the frontline of the push for equity crowdfunding. He discussed the issue with Bloomberg Businessweek’s Brad Stone in June.
  • Testimony from Mercer Bullard before a House of Representatives subcommittee on Sept. 15, 2011.
  • Crowdfunding West held a conference in June in Berkeley, California, featuring a debate with prominent investors.
  • Website for the National Crowdfunding Association, a member organization formed after the passage of the JOBS Act.

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First Published Feb. 12, 2014

To contact the writer of this QuickTake:

Ari Levy in San Francisco at alevy5@bloomberg.net.

To contact the editor responsible for this QuickTake:

John O'Neil at joneil18@bloomberg.net