Join the crowd, and find some funding for your startup
On the Money
From the December 2, 2011 print edition
Conventional wisdom says that family and friends are the first source of financing for a new business.
An entrepreneur presents the new idea to people he already knows. If they decide to invest, it’s as much an investment in the person as the new venture. If he’s successful, he’ll get a high number of personal investors, each investing a little.
In the past, reaching out to acquaintances took a great deal of time, many phone calls and a lot of postage. That’s not true today. Internet and social networking sites have made connecting with friends and family happen in milliseconds.
On the other end of the spectrum, the Securities and Exchange Commission was formed to slow down and protect investors from falling prey to the overzealous (and sometimes unscrupulous) sales pitches of enthusiastic entrepreneurs.
The SEC’s role can be stated in one sentence: Every share of stock must be evaluated and registered, every seller of stock must be examined and licensed, and every trade must be made public, unless there is an exemption.
The phrase “exempt from registration” (also known as “private placement”) has allowed friends-and-family funding to be successful.
Many people say SEC rules unduly limit small businesses’ ability to raise money in the public domain. The cost of registering securities for offer is offensively expensive in the United States. Private placements are restricted to high-net-worth individuals, which excludes the overwhelming majority of Americans.
Now, through a confluence of technology, regulation and maybe the government’s attempts at stimulating start-up investment, friends and family is about to be replaced with “crowd funding.”
Crowd funding is a way to raise capital, via the Internet, by reaching out to large numbers of people that presumably have a common interest in the mission of the start-up company.
There are crowd-funding websites. There are no securities laws specifically regulating crowd-funding sites right now; which existing laws apply depends upon the rules of each crowd-funding platform. Relying on existing securities laws, here are six crowd-funding sites.
- Profounder (profounder.com), focused on equity and revenue sharing.
- Startup Addict (startupaddict.com), a site specifically for startups.
- Believers Fund (believersfund.com), for new mobile apps.
- Rockethub (rockethub.com), for creative projects, such as art, film and drama.
- Quirky (quirky.com), for inventors.
- Cofolio (cofolio.com), for small businesses.
The SEC is reviewing its rules, given that crowd funding provides an attractive solution to the difficulties involved in raising seed money. Mary Schapiro, SEC chair, said the SEC favorably views amending the rules. However, it remains to be seen what form these amendments might take and how long this would require.
Even more importantly, in order to support crowd funding, Congress is considering exemptions to decades-old securities regulations as a way to provide access to entrepreneurs who want to legally sell equity stakes in their startups through the Internet.
HR 2930 would provide companies the freedom to accept up to $1 million to fund projects and companies. The bill seeks to reduce restrictions and regulations on both companies and investors. For the complete bill, follow this link for a PDF.
The U.S. House of Representatives voted almost unanimously to pass the bill on Nov. 3. The bill will reach the Senate in a few weeks, and should it pass, it could be implemented as early as the first quarter of 2012.
President Barack Obama backs the bill. “The administration supports House passage of H.R. 2930 … [the President] called for cutting away the red tape that prevents many rapidly growing startup companies from raising needed capital, including through a ‘crowd funding’ exemption from the requirement to register public securities offerings with the Securities and Exchange Commission,” Obama said.
However, the North American Securities Administrators Association calls the legislation “well intended, but structurally flawed,” arguing that the bill “will needlessly preempt state securities laws and weaken important investor protections. The potential for fraud in this area is real and potentially enormous.”
Raising startup capital always has been the largest challenge for entrepreneurs.
© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.