Crowdsourcing the Crowdfunding Exemption

There is a growing movement to create a new crowdfunding regime for raising capital. The models seem to draw inspiration from Kickstarter, a platform to fund creative projects. I say that because each time I see a draft bill it talks about an internet-based intermediary as part of the exemption.

President Obama endorsed the idea of a crowdfunding exemption. That has lead to three bills in Congress, plus a proposal being generated by NASAA as a state-run alternative.

President Obama cheered for crowdfunding as part of the American Jobs Act unveiling. The statement talks about the millions raised through Kickstarter in the form of donations. That’s not exactly right. The offering is sometimes a pure donation, but more often is linked to a product in development.

The Entrepreneur Access to Capital Act (H.R. 2930) permits “crowdfunding” to finance new businesses by allowing companies to accept and pool donations up to $5 million without registering with the SEC. It would limit individual investments to the lesser of $10,000 or 10% of an investor’s annual income. An amendment requiring a notice filing with the SEC was rejected as was an amendment that would have barred felons from being involved.

NASSA is putting together a model exemption for use at the state level. The various state level regulators are trying to craft this model.

The Democratizing Access to Captial Act (S.1791) was introduced by Senator Scott Brown. This bill is being supported by the Wefunders, who is in the business of being a platform for capital crowdfunding. Unlike Kickstarter, it’s only open to accredited investors.

Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2011 (S. 1970) was  introduced by Senator Merkley. This bill has the right acronym.

What they all have in common is some cap on the total funds that can be raised and a cap on how much someone can invest.

I’m all for making it easier for entrepreneurs to have easier access to capital. The registration and legal limits on capital-raising deter lots of projects. However, they also vet projects. To some extent, excluding the unworthy. It also tends to deter lots of worthy projects.

I like the project crowdfunding at Kickstarter. There is no expectation of riches, other than whatever trinket or completed example of the project they promise to you in exchange for your funding. I have no concerns about the dilution of shares, executive compensation, ratchets, and follow-up rounds.

Capital crowdfunding should be an interesting experiment. I predict it will create lots of new jobs and fund lots of interesting projects.

I also expect that it will be suspect to fraud. I expect that there will be many disappointed small investors who expected to reap fortunes, instead being stuck with worthless shares in failed companies or companies that existed only to funnel cash to fraudsters.  The extent of that fraud will depend on how well Congress crafts a crowdfunding bill. I expect they will come up short.


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5 Responses to Crowdsourcing the Crowdfunding Exemption

  1. Dave February 10, 2012 at 11:50 am #

    Investment crowdfunding has the unique ability to become an incremental source of funding for startups and small businesses. Which in turn will create jobs and jump start our economy. Yes, angels, VCs, and other funding options exist, but many are out of reach to most entrepreneurs. We should do everything in our power to push for the legalization of investment crowdfunding.

    You are right to be concerned about potential scams and proper controls need to be in place. But let’s not over fear the potential for fraud versus the potential for good. Under well established oversight, massive scams have been committed – Enron, Worldcom, Tyco, HealthSouth, and Bernie Madoff duped investors out of billions of dollars in the last decade alone. It would take literally thousands of fraudulent crowdfunding campaigns to equal the value of one of those examples.

    This blog post compares the existing crowdfunding bills and provides an ideal solution which carefully balances the viability of crowdfunding as a source of capital against the risk of fraud:

    • Doug Cornelius February 13, 2012 at 7:20 am #

      Dave – The key to a good regulatory environment is striking a balance between keeping out the bad actors, but allowing for the underlying user base to thrive and innovate. That balance largely does not exist in our securities law framework. In part, Congress messes up the enabling legislation and the SEC leans more to paternalistic protectionism.

      I thing crowdfunding is good in concept, but I think Congress and the SEC will create something that does not work as well as the concept.


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