2,822 crowdsourcing and crowdfunding sites
We could be standing on the precipice of a new era for crowdfunding. Imagine a level playing field for early-stage entrepreneurs and small businesses operating within the largest economy on earth. Envision unprecedented access to previously restricted capital sources in the range of a few hundred thousand dollars up to $2 million. The result could be fundamental changes for not only the potential growth of crowdfunding, but for how capital is raised in general.
The foundation for such a revolution is currently being laid out in the U.S. Congress. A handful of legislative proposals could finally modernize out-dated regulations that stifle the creation of jobs and growth of small businesses by enabling the pooling of capital through equity-based crowdfunding platforms. The inherent democracy and ever-increasing collective wisdom of the crowd could become a new tool to dynamically evaluate potential investments, helping to filter out scammers and build integrity into the capital mechanisms. Crowdfunding communities, entrepreneurs and small business owners across America are eagerly awaiting the change.
Here I discuss the bills' timeline and process, compare the different proposals currently before the Senate, and weigh the potential benefits for investors and entrepreneurs. A follow-up post will take an in-depth look at some of the central criticisms of the crowdfunding bills. Also see our visual timeline of the bills' progress.
The three proposed crowdfunding bills provide registration exemptions from decades-old Securities and Exchange Commission (SEC) regulations that prohibit anyone other than high net worth accredited individuals from purchasing a stake in private companies. Currently no legal way exists for everyday citizens to directly invest in companies for equity. In their current forms, the proposals would reverse the status quo and empower members of the crowd to invest in ventures in the earliest stages.
The bills could also help alleviate the critical capital shortfall faced by entrepreneurs and small businesses seeking funding up to $2 million. Part of the hope behind the bills is that they will build confidence in innovative crowdfunding capital raising models, while simultaneously putting protections in place for investors. If these promises are fulfilled, the fundamentals of raising capital in the US could change rapidly.
The movement towards legal crowdfunding in the U.S. began in July 2010, when the Sustainable Economies Law Center (SELC) sent a petition to the SEC asking the agency to provide an exemption for businesses seeking up $100,000 with individual investments capped at $100. Fittingly, the petition was crowdfunded on IndieGoGo. Over the next year, grassroots support for the notion grew. A Congressional hearing was held for the Startup Exemption's crowdfunding framework and President Obama offered his endorsement of the exemption in September of 2011.
That month the first bill--the Entrepreneur Access to Capital Act (H.R. 2930), based around the Startup Exemption framework—was introduced in the House of Representatives. Seeking to exempt businesses raising up to $2 million via online platforms, it included a higher threshold of $10,000 or 10% of income as the individual investment cap, and would also override state regulatory authority.
Only a few weeks later, Senator Scott Brown introduced the Democratizing Access to Capital Act (S. 1971), and the following day the House bill passed overwhelmingly, 407-17. The second bill tracks the first on most points, but has a lower individual limit of $1K and a maximum investment offering of $1 million.
A third bill, the CROWDFUND Act (S. 1970), also debuted in the Senate in December. Also stating a maximum cap of $1 million, this bill provides more complex, tailored individual investment limits.
As if that weren't enough, a fourth proposal has also taken shape, although so far it remains on the sidelines. Created by the North American Securities Administrators Association (NASAA), a group of state and provincial regulators, the proposal largely tracks the first Senate bill but preserves regulatory authority for the states.
While the House bill passed with bi-partisan support, the other bills have stalled in the Senate over concerns of adequate investor protections and over-regulation. If a bill passes through both chambers, they will then have to be reconciled into a single bill and re-passed by both the House and Senate before heading to the White House for President Obama's signature.
With the Obama Administration publicly backing the idea, and the driving force of tight capital markets combined with an urgent need to stimulate job creation, there's reason to be optimistic that a crowdfunding exemption will be passed into law in the near future. The SEC must then convert the legislation into a regulatory regime, giving the agency a powerful final say in determining whether a new crowdfunding framework will be easy to use, and how much of a transformative impact the changes can have on capital markets.
Strong process advantages can be attributed to sourcing capital through crowdfunding, as the access to capital is extremely fast and the process itself is inherently transparent. In comparison, traditional angel or VC funding is usually characterized by slow access to capital and an opaque process mechanism.
Access to a much larger pool of potential investors offers more chance that entrepreneurs will connect with relevant funders who can help raise the amount of capital needed. Another unique advantage is that raising funds online presents an exceptional opportunity to build value-added relationships and community loyalty. A substantial buzz can be generated about a new company, creating demand and building a fan base even before launch. The larger the crowd invested in a venture’s success, the more people are likely to support the venture and a powerful network effect may be exploited.
While some herald the crowdfunding bills as an opportunity to diversify and innovate in a sector that has been immobilized in an ‘equity gap’ for too long, others speculate there will be a rise in fraudulent online investment offerings if new regulations surrounding investor protection aren’t sufficiently rigorous. (These concerns and other critical responses will be discussed at length in a follow-on post.)
Reconciling the need for ways to loosen regulations that impede small businesses from raising capital and the need for investor protection is a delicate balancing act. Appropriate regulation is crucial to enabling crowdfunding legislation to aid small businesses and entrepreneurs effectively. Over-regulate and innovation will continue to be stifled.
There is little question that online equity-based crowdfunding is a powerful form of finance or that a new crowdfunding bill is poised to revolutionize the way capital is raised. Once a company or two score a financial home run using equity crowdfunding, American entrepreneurs and small businesses will hopefully follow the lead of those in Britain, the Netherlands and Hong Kong, where successful equity-based crowdfunding platforms are already operating.
- Carl Esposti is the founder of Crowdsourcing.org.
For a visual look at the long road to legal crowdfunding in the US, check out our nifty infographic, produced by Dorothy Sanders of Sandfishdesign.co.uk., who also contributed a great deal of research to this editorial.
You can also follow the latest official progress of the bills at the links below.
H.R. 2930 - Entrepreneur Access to Capital Act (Bill progress & updates)
S.1971 – Democratizing Access to Capital Act of 2011 (Bill progress & updates)
S. 1970 – Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2011 (CROWDFUND Act) (Bill progress & updates)