The Internet is the biggest marketplace in the world, and a great equalizer. Take eBay, for example. It used to be that if you collected or sold specialty items, you had to work with a network of dealers and catalogs to find buyers and sellers. Then eBay came along and suddenly it was very easy buyers and sellers to “meet.” Want a used train set, a particular veil to go with your wedding dress or an out-of-print book? Looking for fellow gamers, Van Gogh enthusiasts or Led Zeppelin fans? The Internet can help. It’s the fastest, simplest way to connect people with common interests or goals.
The latest way it is connecting people is through crowdfunding. Sites like Kickstarter and RocketHub offer people with a cause or an idea — artists, writers, video game developers, musicians, politicians, charities — a way to connect with thousands of potential donors. Let’s say you have a band and you need $7,000 to pay for studio time to record your album. You can list your project on Kickstarter and get people to donate small amounts of money to get you to your goal. Or a teacher can go to a nonprofit site like Donors Choose and solicit donations to fund special classroom projects. For example, it only takes 350 people giving $20 to get you to $7,000. It’s a case of the Internet acting as a gamechanger yet again, introducing people with projects to “financial backers” who are regular people just like you.
So why hasn’t this model caught on for private businesses looking to raise cash? Simple. It was illegal…until now.
The Jumpstart Our Business Startups (JOBS) Act, signed into law by President Obama last week changes the rules, allowing private companies to raise up to $1 million dollars from individual investors without going public. It’s designed to make it easier for startups and small businesses to raise money. They used to be restricted to getting money from what the SEC calls accredited investors (defined as having a net worth of $1 million or more excluding primary residence or a minimum annual income of $200,000 for the last two years) only. Under the JOBS Act, any investor will be able to buy in to a private equity offering. All they have to do is certify that they understand the risks of investing in a startup.
The Act’s proponents are calling it a victory for entrepreneurs and saying it will change the way startups and small businesses are funded. The detractors say it loosens the rules too much and will lead to disaster.
So, how big a difference will being able to get money through crowdfunding make for small businesses and startups? In some ways it really could be a gamechanger. There are a lot of positives to this Act, but I think the biggest impact will actually be at the “mom and pop” level, helping small businesses that normally wouldn’t have a chance at getting a loan or venture capital funding. That’s where the JOBS Act has the most potential to actually create jobs.
Another place access to crowdfunding will help is by giving startups more time to grow and refine their business models before making an IPO, which could lead to higher quality IPOs in the long run. It will also help companies that don’t wish to go public stay private, since they are no longer limited to 500 investors. The new limit of 1,000 investors will allow them to raise more funds without jumping through all the hoops required to go public. That’s a great way to fuel growth and innovation.
For individual investors, the Act opens up the opportunity to get in on the ground floor with a startup company, and with it the potential to build real wealth (in theory). You know one of the reasons I advise investors to steer clear of most IPOs is that the deck is stacked against the average investor trying to get the stock at a good price. That could change with crowdfunding investing. Of course this also opens up increased risk. Most startups do not turn out to be the next Google. In fact, many of them fail outright. There’s also an increased risk of fraud. No one is sure exactly how crowdfunding will be regulated yet, and you can be sure there are scammers lining up to take crowdfunding money.
The Act won’t take effect until 2013, so we still have a wait to see how this will all play out. There are already crowdfunding websites out there that have been waiting for the JOBS Act to be passed, so you can rest assured that there will be plenty of companies ready to start accepting investments on day one.
The bottom line for investors interested in trying crowdfunding, in my opinion, is pretty much the same as it would be for any investment. If you see a crowdfunding opportunity that looks interesting, do your due diligence, research carefully, and only invest money you can afford to lose.