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Crowd Funding: A Loan In A Crowd

While internet commerce for most of us means internet shopping, we know that the Web has become an extremely potent channel for raising money. Up to this point, though, it’s been mostly limited to the political and non-profit universe.  

The crowd funding phenomena has begun to impact the business, regulatory and financial environment in ways that promise great opportunity for individual investors, and have the potential to fundamentally transform capital markets around the globe.

So what is crowd funding? It’s really a new name for the age old process of raising money outside normal investment channels, but using the resources and scope of the internet.

Think of a writer taking private subscriptions for a novel, a sculptor trying to obtain money from wealthy donors to build an art installation, or a filmmaker raising funds from friends and family to produce a movie. Add in the global access represented by the internet and the potential increases exponentially. Up to now, the use of this type of funding for business enterprises has been very tightly regulated (and that’s a good thing); however, the regulatory environment has begun to evolve to reflect the dynamics of the 21st century, and the implications for new capital formation and innovation are staggering.

The JOBS act, signed by President Obama in April 2012, created a new exemption from registration by U.S. companies offering securities through an SEC registered “CrowdFunding” platform. Under this model, companies who are not licensed broker-dealers can register with the SEC and conduct business as funding portals.

In order to protect investors, most companies raising public funds must go through a lengthy registration process. However, there is always a trade-off between protecting investors, and limiting the ability of individuals to invest in new, innovative, but sometimes risky offerings. The SEC has recognized that in many cases the cost of registration may be both burdensome and unproductive, and may actually detract from innovation and creativity. So it has created exemptions from registration for certain types of private offerings.  However, these offerings have strict limits on how they are marketed and promoted, and significant restrictions on who can participate. These offering are typically limited to a group known as accredited investors, defined as an individual or couple with a net worth of $1,000,000 excluding their residence, or income exceeding $200,000 in each of the two most recent years ($300,000 for joint income.) 

 

Under the new JOBS ACT, the SEC has until December 31, 2012 to issue the new regulations governing crowdfunding in a venture capital environment; this deadline will probably be extended, as the SEC regroups itself under a new chairperson. However, the first set of rules, known as the “Sunshine Act,” was released this summer. They involve a relaxation of general solicitation guidelines for accredited investors; in plain English, expanding the use of the internet in publicizing and promoting new ventures, but still limited to accredited investors. The next set of rules could deal with the use of  crowdfunding platforms to solicit capital funding directly from individual investors, who would not have to be considered “accredited” in order to participate. This would have the effect of opening up new channels of business investment to a new universe of potential investors.

A number of crowdfunding internet businesses are already in successful operation, using rewards-based models. These models could allow them to evolve into true investment portals as SEC guidance become clearer. One of these, Kickstarter.com, began in 2009 as a funding site for creative ventures, and has raised over $350 million for over 30,000 projects, from more than 2.5 million people. Kickstarter fundraising cannot be used at this time to offer financial returns to investors, only special recognition, a copy of creative material like a limited edition, or an opportunity to participate in the rewards of the project.  While Kickstarter doesn’t vet every project, they do have a due diligence process to screen folks wishing to have their project listed.  Funding is an all or nothing proposal; potential investors use their credit cards to make pledges, and they are not charged for their investment until 100% of all funds for a project have been successfully raised. Then the money is released, and Kickstarter takes a small fee.  The project sponsors must successfully complete their project as represented to the investors; otherwise they are legally obligated to refund all of the money raised.

Recent Kickstarter projects requesting funding include an electromagnetic radiation detector that plugs into your IPhone (fully funded,) a choose your own adventure book based on Hamlet, featuring ghosts, jokes, and a previously unseen pirate fight, (also fully funded,)  Nightwing, a TV mini-series based on Batman (about 50% funded,) as well as numerous albums, concerts, books, dance performances, and aspiring musicians.  It’s an intriguing concept, and in the near future we are likely to find out how this decidedly 21st century approach might open up the world of start-ups, business development and venture capital to the ordinary investor.  In the meantime, you can check out how crowdfunding works for yourself at www.kickstarter.com.

Steven Weber, Gloria Harris, and Frank Weber are the investment and client services team for The Bedminster Group, providing investment management, estate, and financial planning services. The information contained herein was obtained from sources considered reliable. Their accuracy cannot be guaranteed. The opinions expressed are solely those of the authors and do not necessarily reflect those from any other source.

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