New World of Crowdfunding Waits as SEC Struggles to Complete its Job

4/9/13Follow @MichaelXBD

Almost exactly one year ago, a new age for entrepreneurs and investors was supposed to have begun.

On April 5, 2012, President Barack Obama signed the Jumpstart Our Startup Businesses, or JOBS Act, into law. Among the act’s provisions were changes to regulations governing how entrepreneurs, startups, and small companies could raise money through crowdfunding and who would be allowed to invest in companies.

Potential investors and entrepreneurs greeted the JOBS Act enthusiastically. Companies formed to help connect entrepreneurs with investors, including a number in Boulder, CO. Their goal was to build on the online crowdfunding model pioneered by companies like Kickstarter, Indiegogo, and RocketHub, which help raise money for creative projects and social campaigns. In exchange for contributing, donors are given a product like a CD or are able to support a cause.

Globally, crowdfunding platforms raised $2.7 billion in 2012, an 81 percent increase from 2011, according to research and advisory firm Massolution, which follows the industry. Massolution’s report covered more than 300 platforms and more than one million campaigns.

Equity crowdfunding is projected to be even bigger. In its recent “State of Entrepreneurship” report, the Kaufmann Foundation cited a study estimating the total market for equity crowdfunding could be $4 billion.

The regulatory changes promised great things, at least in the eyes of supporters, but the year since has frustrated many and led to major pivots for some companies that formed to act as connectors between investors and entrepreneurs.

“I’ll admit, I went into this with wide eyes, thinking this would mark a renaissance for investors,” said John Metzger, co-founder and CEO of TeQuity Capital & Communications, formerly the Story Stock Exchange, which was launched in Spring 2012.

Finding Capital and Making Connections

Finding the money needed to get a company off the ground is a problem shared by almost all entrepreneurs. While it may be easier for some—like serial entrepreneurs with a successful track record running software startups—for new entrepreneurs it is one of their biggest challenges.

Raising money from the proverbial “friends, family, and fools,” is an option, but their resources are finite, and the pool of angel investors can vary greatly by area and industry. A first-time entrepreneur likely will have a limited network, and while his or her idea might be sound, it might not offer the high returns venture capital firms want.

Reaching out to the public is not a possibility either, because of SEC rules against general solicitation.

Equity crowdfunding is supposed to help entrepreneurs overcome those hurdles.

While crowdfunding has been around for a few years, before the JOBS Act it was limited to companies, individuals, or organizations making a product, starting a creative project, or raising money for a philanthropic campaign. The key innovation of the JOBS Act was to allow entrepreneurs to sell part of the company in exchange for investment. The law allows companies to raise up to $1 million a year through selling shares.

As with Kickstarter, they would be able to use online platforms that would broaden their reach and connect them with investors far outside their geographic area or personal network.

The platforms would be more democratic as well, because regulations limiting investors to “accredited investors”—read rich people, financial institutions, and VCs—were relaxed for individuals using the platforms to invest.

Entrepreneurs and the media quickly recognized the potential benefits and foresaw a world where entrepreneurs could amass many small investments from around the country to support their companies.

“That was really the Holy Grail, the promise of what it would be, and … Next Page »

Michael Davidson is the editor of Xconomy Boulder/Denver. He covers startups, venture capital, clean tech, energy, aerospace, telecoms, and whatever else happens above 5,280 feet. Contact him at mdavidson@xconomy.com. Follow @MichaelXBD

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