Businesses Eager to Draw Investment Capital Latch on to Crowdfunding

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What do you get when you mix the virality of the internet with deep pockets? Businesses hope you get a platform for fundraising.

Small and medium businesses around the country are turning to a new form of fundraising – crowdfunding. Crowdfunding was spawned from the idea that many different contributors could pool funds to help a small business. So far, the idea has had to avoid a common legal hurdle: securities law. The Securities and Exchange Commission, the same group that regulates the stock and bond markets in the United States, has legal policy that makes crowdfunding illegal.

However, those laws will soon be overturned. As part of the Jumpstart Our Business Startups Act, or JOBS Act, the SEC is asked to review and replace existing crowdfunding laws to allow business owners to sell equity in their own business. The law is widely expected to free up the financing markets for small businesses, which will be able to sell shares in the enterprise through online crowdfunding sites.

Currently, small business owners can only source non-equity forms of financing. Some turn to Prosper and Lending Club, businesses which allow individuals to lend to individuals. Others are turning to sites like Kickstarter, which allow business owners to presell their products to a large audience, gaining both immediate cash for startup costs as well as publicity. Some of the most successful Kickstarter campaigns have raised more than $1 million for small businesses.

True crowdfunding will not begin until January 2013 at which point the SEC is required to put in place firm new rules surrounding the sale of shares in a small business. If the policy is approved, individuals will have the opportunity to invest in small businesses and receive shares in the company in return.

Only accredited investors can invest in private equity transactions as the law stands right now. The SEC requires investors to reach “accreditation,” which includes an income of more than $200,000 or assets (excluding a home) of more than $1 million. Unfortunately for small business owners seeking cash, there are far more people who earn less than $200,000 than there are people who earn more than $200,000. And the number of millionaires is much smaller than the number of non-millionaires.

The law will allow investors to invest $10,000 or up to 10% of their annual income in a small business in exchange for equity. It will also overturn securities advertising laws so that small business owners can publicly advertise the sale of stock in their company. Finally, the law will increase the maximum amount of fundraising to $2 million – and the SEC will approve private companies to have as many as 2,000 shareholders. Currently, the SEC limits the total number of shareholders to fewer than 500 – many have 499 shareholders to avoid tripping this problematic limit.

Crowdfunding may soon become a critical source of capital for growing business that are too small to grab attention of venture capitalists and too large to be sustained on the owner’s balance sheet.

One Response

  1. Dennis Chiles

    I’m about to start a project using a crowdfunding site. One of the great things about crowdfunding is that you really can use it to validate your start-up. If you can get it in front of enough people, and it is something people really want or need, I’m confident it’s going to get funded.

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