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F*** the Banks. Crowdfunding is Here.

Posted on Tuesday, 4th October 2011 @ 12:25 PM by Text Size A | A | A

Be Your Own Bank:
New Laws Could Unleash Crowdfunding For Startups

As politicians left and right lament that stingy banks won’t lend “to
get the economy going again,” another source of capital sits untapped
precisely because the government stands in the way: You, me, and anyone
else who wants to invest directly in fledgling companies.

With
wheels turning in Washington, that may soon change. When it does, the
first beneficiaries are likely to be social enterprise—business with a
social mission.

Crowdfunding
sites
 like Kickstarter and IndieGoGo have set the standard
for creative types looking to launch a project on small donations, but
the casual donor crowd doesn’t have the scale to spark an economic
recovery, nor get a $5 million startup off the ground and hiring new
workers. That requires investors, not donors, but the Securities and
Exchange Commission forbids crowdfunding for businesses, as it has for
more than 75 years.

“If people are already signing up to give $25
to someone to make an album, then there’s enough demand for
[microinvesting],” says Freeman White, who founded Launcht, a
crowdfunding platform.

Imagine a Kickstarter 2.0 where, for a sum
of around $250, you get part-ownership in a company instead of a thank
you note and t-shirt. There are already a small handful of companies
lining up to facilitate crowdfunding, some flying under the radar of
regulations and others chomping at the bit and pushing for change.

“Right now it’s the Wild West; there’s no real definition of what
crowdfunding is,” White says. “We want someone to tell us: How many
investors can a company have? And how much can they invest? If we got
that clarity…sites would do what they had to do to let every common
person on the internet start investing in every startup.”

He may
soon get his wish. President Obama has called
for a lifting of the SEC ban
 as part of his jobs plan. “Right now,
entrepreneurs like these
bakers
 and these
gadget-makers
 are already using crowdfunding platforms to raise
hundreds of thousands of dollars in pure donations—imagine the
possibilities if these small-dollar donors became investors,” two White
House officials wrote in an explanation
of the policy
.

Most investing rules—like the Securities and
Exchange Act of 1934, which bans crowdfunding—date to overhauls that
followed the 1929 stock market crash. They are designed to protect
unsophisticated, generally low-income investors from fraud. Among those
rules is a limit on the number of people who may invest in a private
company before it must subject itself to the increased scrutiny of the
public markets; the federal cap is 500 investors. Obama wants to remove
that limit.

We all know Obama likes the idea of legions of small
donors coming together for a cause, but the policy isn’t just nostalgia
for 2008. Despite general objections to Obama’s jobs policy, some
Republicans are on board too. Congressman Patrick McHenry (R-NC) has introduced a bill removing
the cap on small investors. To protect against scams, the law limits
crowd investors to no more than 10 percent of their income or $10,000,
whichever is less.

“With so much difficulty obtaining capital in
today’s economy, most business ideas never make it past the dinner
table,” McHenry says. “This legislation will connect entrepreneurs with
everyday investors to help get their businesses off the ground.”

Jessica Jackley has been doing that for years, first as founder of Kiva, now at the helm of Profounder, a peer-to-peer
investing site that is among the more advanced crowdfunding platforms.
Profounder originally tried to offer loans to startups that were repaid
based on the company’s success. Regulators put the kibosh on that plan
and Profounder is now considering other business models.

Jackley
and her cofounder, Dana Mauriello, are frustrated by the current laws
and how hard it is to raise money for the smallest of startups.
“Dana and I saw our classmates at Stanford trying to raise money for
startups, but they couldn’t get it done.” Jackley says. “One classmate
sent an email asking for $1,000 investments,” but under California law
he couldn’t accept money from sixty interested investors. Eventually,
after legal costs, it cost him $20,000 to raise $35,000.

The
demand for this kind of investment exists, especially for social
enterprise. When Jackley’s previous company Kiva offered anyone the
opportunity to make zero-interest loans to microentrepreneurs in the
developing world, they had more lenders than they knew what to do with.
Those Kiva donors are already comfortable lending online, with many
lending to American businesses through the company’s new Kiva City platform.

Asked
to predict what the first wave of crowdfunded businesses will be,
Jackley says “I think social enterprises, I think retail. Anything that
is a consumer brand that people love and can relate to and feel like
they can be a apart of. When there’s a social benefit attached to it,
that’s huge.”

Proponents of crowdfunding say fraud isn’t as much
of a concern as it was in 1934. Sites like eBay have managed to vet
users well, creating trust and accountability and displaying good best
practices for crowdfunders.

Government regulations are “a very
legitimate response to protect investors from getting ripped off” says
Antony Bugg-Levine, co-author of “Impact
Investing: Transforming How We Make Money While Making a Difference
.”
Countries around the world are reviewing their laws on investing, he
says, in large part because investing isn’t just about making money, or
saving for retirement anymore. Now, investing and social enterprise is a
tool for social change.

“We have to think of new ways to unlock
capital for the business that can address social challenges, while
still protecting investors from bad investments,” he says, predicting
that the same new technologies that enable crowdfunding in the first
place will also enable fraud protection.

Jackley and White are
standing by to prove it. “We’ll actually change the world,” White says.
“That’s why we are in this.”

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