New legislation that could free up start-ups to fundraise online is gaining steam. Here's how it could disrupt traditional capital formation.
Republicans and Democrats may finally agree on something: Small business owners and entrepreneurs need better and more plentiful opportunities to gain access to capital, grow their businesses, and create more jobs.
In addition to the overwhelming bipartisan support the bill received in the House, the President supports it as well. In a September 8 address to a Joint Session of Congress on jobs and the economy, the President urged Congress to remove the red-tape—and SEC restrictions—that make it difficult, if not illegal, for entrepreneurs to raise funds in public.
"This bill will make it easier for entrepreneurs to raise capital and create jobs," the White House noted in a statement. "The Administration looks forward to continuing to work with the Congress to craft legislation that facilitates capital formation and job growth and provides appropriate investor protections."
Senator Scott Brown of Massachusetts, a vocal Republican supporter of crowdfunding, addressed the Senate Banking Committee last week, urging members to consider crowdfunding as a viable method for entrepreneurs raise funds. He described crowdfunding as "the grease that keeps the gears in the American economy churning."
Current online investment platforms—such as Kickstarter and Indiegogo—allow people to offer funds for projects, though they do not offer true equity in return. Sites like Microventures do offer equity, but to invest you must be an angel investor. Right now, there's no legal way for unaccredited people to invest in companies for equity.
"Imagine that," Brown said. "The next Steve Jobs being held back by rules from the age of the typewriter. When are we going to give the tools and resources to our job creators? [Crowdfunding] is an innovative way to look outside the box and get up with the times to open up capital markets to new businesses and existing small businesses. It has the potential to be a powerful venture capital model."
Although much large-scale crowdfunding still illegal in the United States, there are several crowdfuning firms overseas already connecting investors with entrepreneurs. Symbid, a Netherlands-based crowdfunding firm, enables entrepreneurs to secure funding from €20,000 up to €2.5 million. Crowdcube, which is based in the U.K., offers a similar service, but with no investment maximum. Entrepreneurs go online, write their pitch, and offer two numbers: the target—which is the total amount of money they wish to raise and invest in the business—and the equity offered.
Critics to the bill argue that devious entrepreneurs will have open range to set up phony companies and lull neophyte investors into dropping them cash. And because there's potential for thousands of daily transactions, there would be little oversight. Brown, though, believes the benefits outweigh any risks.
"Americans are allowed to gamble unlimited amounts at casinos, and can send donations to charities halfway around the world with one tap of a trackpad," wrote Brown in a recent Wired editorial. "Yet, we are legally prevented from making even modest investments in job-creating small businesses."
Carl Esposti, the founder of Crowdsourcing.org, points out another argument: that the investment risks involved are actually lower, since there will be many investors doing due diligence on the investment. Therefore, he says, if 150 or 200 people decide to vote on an entity, the aggregate of the risk assessment might indicate that that entity is not such a bad bet.
"There's an interesting dynamic on whether it actually creates a natural calibration of risk-reward," Esposti says. "From that perspective, it has some really interesting potential."