The world is on the threshold of a fundamental transformation in how small businesses raise money and new companies, products, and services are created. Soon startups will be able to use crowdfunding to sell sell securities on social networks and other websites. The democratization of capital is at hand.
What Is Crowdfunding?
Crowdfunding is a form of microfinancing where, instead of a small number of venture capitalists or well-heeled donors cutting checks, funding is provided by larger groups of people who network and pool small amounts of money and other resources.
Crowdfunding is used for a variety of purposes, from disaster relief to journalism and publishing, to artists, film-makers, and musicians seeking support from fans, to creating software or funding start-up companies and small businesses.
Crowdfunding allows good ideas which do not fit the pattern required by conventional financiers to bypass these gatekeepers and attract cash through the “wisdom of the crowd.” If the idea gets traction in this way, the enterprise can not only secure seed money to begin its project, but receives the additional benefit of positive word-of-mouth promotion and may also attract further interest by being able to show evidence of backing from potential customers.
Crowdfunding has its roots in the emergence of microfinancing in the 1970s as a way of providing people of limited means with access to capital. More recently the idea has been adopted to the online funding of creative projects. Raising small amounts of cash from large groups of investors has been popularized by websites like Kickstarter, which allows people to donate to fund artistic ventures; Kiva, a micro-finance program; RocketHub; and Crowdcube. On these sites, which are often for non-profit causes or creative projects, people give donations and typically receive in exchange a souvenir or first run sample of the product they helped fund.
New federal legislation now promises to give crowdfunders the opportunity to become actual investors with a financial stake in a company.
The Crowdfunding Bill
H. R. 2930, The Entrepreneur Access to Capital Act, informally known as the Crowdfunding Bill, is part of a legislative package called The JOBS (Jumpstart Our Business Startups) Act. Introduced by Representative Patrick McHenry (R-SC), it was approved by the House of Representatives on March 8, 2012 in a vote of 390 to 2. Two versions of the legislation have been introduced in the Senate – the Democratizing Access to Capital Act, introduced by Sen. Scott Brown (R-MA), and the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act (or CROWDFUND Act) introduced by Sen. Jeff Merkeley (D-OR). Senate majority leader Harry Reid announced plans to push forward similar legislation in the wake of House approval.
The Crowdfunding Bill has drawn bi-partisan support in both houses of Congress and the White House has expressed support for the House bill. Upon passage of a Senate bill and its reconciliation with the House bill, it is expected to be signed by President Obama.
This will give entrepreneurs new options to consider when raising money for their startups.
What Does the Crowdfunding Bill Do?
The Crowdfunding Bill removes Securities and Exchange Commission (SEC) restrictions dating from 1934. These restrictions have been preventing the use of crowdfunding, limiting entrepreneurs’ ability to raise equity capital from a large pool of small investors who may or may not be accredited by the SEC.
The Crowdfunding Bill changes this by allowing companies to pool up to $1 million from investors without registering with the SEC,or up to $2 million if the company provides investors with audited financial statements. Individual contributions are limited to $10,000 or ten percent of the investor’s annual income, whichever is less.
What Will Happen When the Crowdfunding Bill Passes?
Under current laws, startups may not sell stock or other securities through crowdfunding sites or social networks, such as Twitter or Facebook. They may only accept donations. Passage of the Crowdfunding Bill will mean smaller companies can raise money without having to deal with expensive and time-consuming SEC processes and laws which have been on the books over 70 years, and provide the necessary funding for the development of new technologies, products, and services. This will in turn create new jobs and provide new and exciting ground-floor opportunities for small investors. The potential for crowdfunding to transform the way start-ups access capital is staggering.
What Are The Risks of Crowdfunding?
There is potential for fraud, unrealistic expectations and speculation by investors, and mistakes due to lack of vetting and coaching of management by experienced venture capital providers.
How Does The Crowdfunding Bill Address These Risks?
The Crowdfunding Bill addresses these issues by:
Limiting a company to raising a maximum of $1 million (or $2 million if the company provides potential investors with audited financial statements);
Limiting each investor to investing an amount equal to the lesser of
10 percent of his or her annual income; and
Requiring the issuer (or the intermediary) to take a number of steps to limit investor risk, including
warning investors of the speculative nature of the investment and the limitations on resale,
requiring investors to answer questions demonstrating their understanding of the risks; and
providing notice to the SEC of the offering, including certain prescribed information.
Our Purpose at Crowdfund News
- Keeping you updated on crowdfunding legislation.
- Providing you information on how to comply with the Crowdfunding Bill once it’s been enacted.
Teaching you how to prepare a crowdfunded offering or contribute to a crowdfund.
Teaching you how to submit filings, present and market, and create business plans for crowdfund offerings.