Raising Money from the Crowd (Version 2.0)

I’m interested in how the “power of the crowd” can be harnessed not only in terms of work (crowdsourcing), or predicting the future (prediction markets), but also how crowds could help businesses and investors.  Enter crowdfunding.  Benefits: entrepreneurs are able to communicate information about their businesses and endeavors to a wide audience, and investors with small amounts can get involved.  According to Lawton and Marom, crowdfunding covers a multitude of activities:

Crowfunding describes the collective cooperation, attention and trust by people who network and pool their money and other resources together, usually via the Internet, to support efforts initiated by other people or organizations . . . The crowdfunding space is quite diverse, comprised of many niches, and shares a lot of social networking’s energy.  Whether to solicit donations and create a fan base for an around-the-world sailing adventure, to pre-sell copies of a book, or to finance a startup in return for equity, some form of crowdfunding is available.

Pooling their money allows individuals with only small amounts to invest the ability to join in the market, often helping artists and musicians produce their work and or to help charitable organizations get off the ground. 

Traditionally, there was no exemption from the securities laws for crowdfunding, and advertising on a website was tantamount to a violation of the 1933 Securities and Exchange Act rules against unregistered public offerings.   Rather than promote traditional equity investments, which would run afoul of the Securities and Exchange Commission, crowfunding websites turned to alternate and creative investment forms.  For example, some crowdfunding websites followed the model of the website Kiva, which promotes microfinance, and which promises no return or interest on the amount, just a return of the capital.  In these ways people can put up small amounts of money for a good cause.  Other websites, like Kickstarter and IndieGoGo provide those who put up money a return in the form of discounted products or free merchandise, but not the traditional monetary dividend traditionally associated with stock. 

In a recent article, Professor Steven Bradford was in favor of such an exemption to the federal securities laws, provided that the equity offerings are small in size and the amount of investment were to be limited to a small amount.  The prolific and creative Professor Joan Heminway seemed less sanguine, perhaps because she was concerned about the possibility of fraud and less-savvy investors being duped by a swindle. 

With the passage of the JOBS Act in April, the regulatory atmosphere for crowdfunding has changed significantly.  The new law allows for a limited exemption for crowdfunding (up to $1 million/year, certain limits on amounts per each investor according to annual income/net worth), with particular requirements that crowdsourcing websites and companies on these websites must meet.

I’ll be interested to see what happens with crowdfunding in the upcoming years – will this idea catch on, or is it another Internet fad?  Discuss.

Version 1.0 of this post appeared yesterday (a small portion of a forthcoming article titled “CyberCommodication”).  I had inadvertently posted an outdated excerpt from the article from March.  Thank you to the astute reader who caught the issue, and my apologies for the mistake.

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3 Responses

  1. Steve Bradford says:

    Thanks for the cite. You might also want to see my new draft on the JOBS Act crowdfunding exemption. It’s available on SSRN at http://ssrn.com/abstract=2066088

  2. Miriam A. Cherry says:

    Thanks for posting that link, Steve.

  3. Joan Heminway says:

    As Steve suggests in his new draft piece (and as the two of us and others have said since the JOBS Act was signed into law back in April) the costs of the system established by Congress in the CROWDFUND Act may be so high that the only businesses that may be able to raise capital using that system will be those who have generated enough capital through other means to be able to afford the crowdfunding option. We’ll see. We cannot really even create a cost model for these offerings until the SEC regulations are adopted, and that will not take place for many months. So, bottom line, crowdfunded securities offerings by the small businesses that are and were using crowdfunding to seek funds over the Internet (in transactions not governed by the securities laws, in most cases) may not become a reality under the CROWDFUND Act.