CHICAGO | Mon Dec 12, 2011 2:46pm EST
(Reuters) – A motley crew of backers is pushing Congress to loosen restrictions on crowdfunding, the new capital-raising method that uses the Internet to solicit start-up investment, despite warnings about the potential for fraud.
Popularized by online platforms such as Kickstarter and Kiva, crowdfunding currently relies on a donation-style model where fans of an artistic project, venture or nonprofit campaign pledge money in exchange for early product or philanthropic fulfillment.
It seems in Washington, almost everyone is a fan, from conservative Republicans to grassroots liberals; a recent House bill to ease crowdfunding restrictions passed 407-to-17.
Broad-based support for crowdfunding is a natural fit because it’s in everyone’s interest to improve the flow of money to small companies during a prolonged weak economy, said James Angel, an associate professor at Georgetown University’s McDonough School of Business.
“The real question is how do you protect investors from the inevitable fraudsters,” Angel said. “That’s where the fine tuning comes in.”
With everyday citizens able to invest in new companies at the earliest stage of development, the fundamentals of startup funding are changing rapidly.
Current SEC rules make it illegal for companies at this stage to solicit securities investment from unaccredited investors. But with pending changes, the capital-raising method could start to draw closer attention from traditional investors.
“Folks have talked about the issues of having unsophisticated investors getting involved here, the possibilities of fraud, and I think the SEC is going to have to seriously look at this,” said Mark Heesen, president of the National Venture Capital Association.
Following last month’s House bill, the Senate is now considering a similar measure at a time when legislators are looking for ways to ease SEC restrictions that make it costly for cash-strapped companies to raise early-stage capital.
The House bill, introduced by Rep. Patrick McHenry (R-NC) and passed November 3 creates an SEC registration exemption for businesses using crowdfunding to seek low levels of investment.
It came on the heels of an overture to crowdfunding included in President Barack Obama’s jobs speech. McHenry’s measure lets a company raise up to $2 million annually from investors who pledge up to $10,000, or 10 percent of their annual income in exchange for small stakes.
“(Crowdfunding) sort of democratizes investing,” said McHenry, adding he was inspired in part by Sherwood Neiss, a Miami entrepreneur and crowdfunding proponent.
“It makes it legal for individuals to have small dollar investments in their favorite brand or product.”
SEC regulations dating back 80 years prohibit private companies from soliciting the sale of securities from individuals other than high net worth accredited investors. Meanwhile, the cost of clearing registration hurdles for small-share offerings puts them out of reach of many ventures in need of growth capital.
A separate crowdfunding bill was introduced in the Senate November 9 by Sen. Scott Brown (R-Mass).
Among other differences, Brown’s bill, which is under review, puts lower thresholds on investment. SEC regulators and others have expressed concern about protecting everyday investors from fraud and mitigating risk by controlling the investment level is seen as one way to ensure protection.
“I think we’re all just super passionate about small business. The types of small businesses we’re passionate about might be a little different,” said Kassan, co-director of the Sustainable Economies Law Center, a grassroots group based in Oakland, California. The group had petitioned the SEC in favor of rule changes allowing for low levels of investment in small businesses from community investors.
“We’re just outraged by the fact that small business is pretty much cut off from the capital markets,” said Kassan, a securities lawyer.
A supporter of McHenry’s legislation, Kassan added that easing restrictions on crowdfunding appeals to some backers of the Move Your Money campaign, which encourages individuals to divest from large financial institutions such as Wall Street banks. Her point further illustrated the diverse support behind the crowdfunding trend.
Who stands to win?
It remains to be seen if the investment levels proposed by in the current bills would be a boon to both community-oriented businesses and growth enterprises attempting to fundraise with subsequent rounds of private financing, such as venture capital, on the path toward eventually going public.
“The lower level is more for community development, people you have a connection to,” said Paul Spinrad, developer of the blog CrowdfundingLaw.com <CrowdfundingLaw.com/> and an influencer of The Sustainable Economies Law Center grassroots campaign.
“A lot of the investor types like the idea but hate the cap.”
In addition, some startups may be too sophisticated to garner interest by appealing to broad-based audiences.
“I think crowdfunding is great for non-complex types of companies,” said Heesen.
“If you’re in the life science field looking at creating a new medical device or a new biotechnology drug, this is a difficult area,” he added.
At the very least, the pending legislation promises to boost the popularity of existing crowdfunding platforms, both for entrepreneurs and their backers.
Slava Rubin, CEO of crowdfunding site IndieGoGo, was optimistic about the impact. “(The legislation) would really open up the funder base,” said Rubin, whose site, which launched in January 2008, distributes “millions of dollars” to a 50,000 campaigns across 206 countries.
Of the organizations that use IndieGoGo to raise money, small business is already the fastest growing, he said.
Coulter Lewis is co-owner of the 15-month-old startup Quinn Popcorn, and raised early-stage startup capital on Kickstarter. The venture was able to raise $28,000 within a month, far exceeding expectations, just on the promise of organic microwaveable popcorn.
The product is now sold in 25 retail stores in the Boston area. “I think it’s wonderful,” Lewis said of potential crowdfunding legislation. “That’s what people are buying – an opportunity to be part of it. As long as they have a limited amount of control, it would be fine.”