In the “stuff you aren’t supposed to do” theme of yesterday’s post, is a piece from Slate about legal restrictions on crowd funding.
While thousands of people can donate to your cause via sites like Kickstarter, SEC rules prevent those same people from investing in your company. If you figure people will donate to people in return for tshirts or other small thank you gifts/services, there is probably a fair bit of potential in getting people to invest in the same project with the possibility of financial return. But the rules say no way.
“Under current law, that is often illegal. A longtime Securities and Exchange Commission rule, designed to protect unsophisticated investors, limits the number of stakeholders certain private companies can have. If you hit 500, you often have to go public. That means opening your books to additional scrutiny and your business to the whims of the market. And being public is just not a feasible option for a tiny business looking for start-up funding. Thus, an artist can receive thousands of $5 donations on a site like Kickstarter, but an incorporated farmer cannot accept investments from thousands of interested small-timers.”
These are some of the same rules that govern investing in Broadway shows and are meant to prevent people from losing large amounts of money because they were not entirely aware of the risks of investing. There is certainly some wisdom in having them.
There are some moves to change this situation. President Obama included such a revision in his American Jobs Act. Even though the act failed to pass, the basic idea has bi-partisan support and some law makers are asking the SEC to change the rules. One petition to the SEC asks for an exemption for investments made in $100 increments as a way to prevent people from losing their life savings. Given that the exemption would mean less oversight of the activities, there is good potential for unscrupulous operators to take the money and run.
Laura Horton at the Legality website has a post that discusses all the legal issues and the efforts to change the rules at length. She reports that the legislation being introduced in Congress, (as opposed to the petition for a rule change to the SEC), would allow a business to raise “$5 million in capital, with a limit on individual investments of the lesser of $10,000 or ten percent of an individual investor’s income.” Horton notes that these companies would be exempt from some of the usual reporting. Hopefully at $10,000 a person, they wouldn’t be exempt from as much as a company getting funded $100 at a time.
Crowd funding at these levels could open the doors for a lot of possibilities, including starting an arts related business. This model might provide a viable alternative to the non-profit structure. It could provide the tools to not only to get an organization started, but also to sustain it over time.
As for how fraud will be prevented, Horton says,
“those in favor of crowdfunding find that investor protection rests on a fundamental aspect of this financing, opening it to lots of people for investment. This “crowd” aspect creates transparency, which may temper the effects of deregulation. There is also a stronger sense of community support through this style of investing. Crowdfunding makes venture capital accessible to small-scale business owners.”
I have to confess some skepticism about this approach being viable in the long run. A crowd can provide good oversight in a small geographic community or when it is performed by investing clubs who meet to research and decide who to fund. My suspicion is that if this type of investment is going to reach any sort of scale, people are going to be doing it over the internet and will rely on Amazon.com type reviews to make their decisions. Presumably, the rating mechanism will be a little more rigorous and have better protections against those who might try to game the system than most online rating websites. It is still likely the system will still be vulnerable to some degree of subversion.
But who knows, it may create a burgeoning industry of companies who meet those soliciting funding and perform objective evaluations and audits. They could post all their findings online accompanied by video interviews, photos of operations, etc for investors to use in their deliberations.