Crowdfunding to hit the big time

| March 6, 2012 | 0 Comments

Crowdfunding is just the investing equivalent of crowdsourcing: using the internet to ask for the funds needed to get a project started. Crowdsourcing sites like Kickstarter and IndieGoGo have been incredibly successful in helping artists, musicians, inventors and other creative entrepreneurs tap the power of the social network to give birth to their labor of love. It’s currently growing by leaps and bounds. For example, Kickstarter thinks that it will help its users to raise $150 million for their creative projects this year — more than the entire budget of the government’s National Endowment for the Arts!

In crowdsourcing, a supporter will usually receive a gift from the entrepreneur in return for his or her donation. They cannot, however, receive equity in the companies that they are helping to start. This would be considered a “private placement” and right now the SEC only allows sophisticated or accredited investors to participate in private placements.

The bar for qualifying as an accredited investor is quite high and probably out of reach for the average Kickstarter supporter. But Congress looks ready to change this. The House of Representatives has passed the Entrepreneur Access to Capital Act, and the Senate is gearing up to pass something similar. If finalized the legislation would allow private individuals to invest up to $10,000 in new companies and to receive equity in return. It would also allow privately held companies to advertise that they are soliciting funds, something that’s currently forbidden by the SEC.

This could be great news for dedicated entrepreneurs who had difficulty accessing bank loans even in the good old days, let alone in today’s capital-constrained environment. And it could give a small boost to an economy still struggling to bring back the jobs lost during the recession and to create the new ones needed to keep up with the pace of population growth.

While the potential is great, the risks cannot be overlooked. Such a system could obviously be exploited by con artists and fraudsters. The SEC is rightfully concerned about how these smaller investors will be protected. This will have to be carefully thought out. So far the proposed mechanisms for doing this include requiring the entrepreneur to outsource cash management of the investments, to verify the investor’s income and to have them answer questions demonstrating that they understand the risks involved. Regardless, it looks like Congress’ bi-partisan push for this bill it will be enough to get it enacted.

Credit where credit is due; a few more positive moves from Congress like this and we might actually get somewhere.

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Category: Investing