Crowdfunding has enabled millions of people to donate money to make prototype products a reality and support artistic projects, among other proposals. In exchange, supporters have received free gifts, verbal thanks, even hugs. Now the stakes are about to increase dramatically thanks to a law paving the way for direct investment in startup businesses.
The new law, a provision of the 2012 Jumpstart Our Business Startups (JOBS) Act, allows startups to market private share offerings to potential investors via websites, social media, and print and television ads. A pre-Internet version of that practice had been outlawed in the 1930s to protect citizens from Great Depression-era scammers.
Today, experts say the ability to pitch to a wide variety of investors will help startups get more early funding faster. “In the past, because you couldn’t publicly advertise the fact that you were seeking investment, your ability to succeed in that was really highly dependent on your personal contacts, your network of investors and your ability to tap into people that way,” explains Gordon Burtch, a professor of information and decision sciences at the University of Minnesota who studies crowdfunding. “This makes life a lot easier from a fundraising standpoint.”
For now only accredited investors—people with $200,000 in annual income or a $1 million net worth—are eligible to fund startups. However, another provision of the JOBS Act to be implemented in 2014 will open up startup funding to all. A new crop of equity-based crowdfunding portals that function similarly to Kickstarter are emerging to connect would-be investors with startups seeking money.
One such website, WeFunder, is already accepting money from accredited investors. Mike Norman, co-founder of the site, says this new approach to venture funding will eliminate inefficiencies he associates with courting venture capitalists and angel investors through in-person meetings. “A lot of this is about their investor experience,” he says. “We’re going to have the ability for everyone to get involved in helping out a company or a startup that they think is really important to get off the ground and be successful.”
Crowdfunding is becoming an increasingly lucrative way to generate capital for everything from movies to consumer electronics. Kickstarter has had a banner year thanks to the influx of celebrity crowdfunders like Spike Lee and Zach Braff. A single campaign for a new smartphone on Indiegogo attracted almost $13 million in funding. The entire crowdfunding sector is expected to generate $5.1 billion globally this year, according to research firm Massolution.
As crowdfunding expands, some worry that deregulation of startup investing will lead to inexperienced investors being duped into bad deals. “That’s the flip side of opening this up to the rest of the world,” says Anindya Ghose, a professor of information, operation and management sciences at New York University who also studies crowdfunding. “You might end up hurting a lot of people who don’t need to be hurt.”
There are some safeguards planned. If startups lure in investors through the new advertising routes, they must gather financial documents to prove that the investors are accredited. Next year, when the investor requirements are lowered, non-accredited investors who earn less than $100,000 will only be able to spend $2,000 or 5% of their income (whichever figure is bigger) on equity crowdfunding investments. The Securities and Exchange Commission may hammer out additional rules before opening the floodgates next year too.
The current leaders in crowdfunding are taking divergent approaches to the introduction of equity into the marketplace. While Kickstarter has said in the past it has no plans to facilitate direct investment in companies, Indiegogo lobbied heavily for the passage of the JOBS Act and seems likely to implement an equity crowdfunding platform once it’s legal. “Indiegogo already distributes millions of dollars across its platform globally each week – once equity investment comes into play we envision this number to grow considerably,” company CEO Slava Rubin said in an email.
They won’t be the only company clamoring for a piece of the equity pie. “You could easily expect tens or hundreds of [crowdfunding] platforms start popping up in the U.S,” Burtch says. “It’s going to become very decentralized. It’s up to the SEC to figure out how they’re going to implement these things in a reasonable manner that makes sense.”