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Crowdfunding, Why the SEC Bans It, Obama Wants It, and Banks Fear It Be Your Own Bank: New Laws Could Unleash Crowdfunding For Startups

The next generation of social enterprises could be funded, and owned, by you and me, if the government opens the door.

As politicians left and right lament that stingy banks won't lend "to get the economy going again," another source of capital sits untapped precisely because the government stands in the way: You, me, and anyone else who wants to invest directly in fledgling companies.

With wheels turning in Washington, that may soon change. When it does, the first beneficiaries are likely to be social enterprises—businesses with a social mission.

Crowdfunding sites like Kickstarter and IndieGoGo have set the standard for creative types looking to launch a project on small donations, but the casual donor crowd doesn’t have the scale to spark an economic recovery, nor get a $5 million startup off the ground and hiring new workers. That requires investors, not donors, but the Securities and Exchange Commission forbids crowdfunding for businesses, as it has for more than 75 years.

“If people are already signing up to give $25 to someone to make an album, then there’s enough demand for [microinvesting],” says Freeman White, who founded Launcht, a crowdfunding platform for business plan competitions.

Imagine a Kickstarter 2.0 where, for a sum of around $250, you get part-ownership in a company instead of a thank you note and t-shirt. There are already a small handful of companies lining up to facilitate crowdfunding, some flying under the radar of regulations and others chomping at the bit and pushing for change.

"Right now it’s the Wild West; there’s no real definition of what crowdfunding is," White says. "We want someone to tell us: How many investors can a company have? And how much can they invest? If we got that clarity…sites would do what they had to do to let every common person on the internet start investing in every startup.”

He may soon get his wish. President Obama has called for a lifting of the SEC ban as part of his jobs plan. "Right now, entrepreneurs like these bakers and these gadget-makers are already using crowdfunding platforms to raise hundreds of thousands of dollars in pure donations—imagine the possibilities if these small-dollar donors became investors," two White House officials wrote in an explanation of the policy.

Most investing rules—like the Securities and Exchange Act of 1934, which bans crowdfunding—date to overhauls that followed the 1929 stock market crash. They are designed to protect unsophisticated, generally low-income investors from fraud. Among those rules is a limit on the number of people who may invest in a private company before it must subject itself to the increased scrutiny of the public markets; the federal cap is 500 investors. Obama wants to remove that limit.

We all know Obama likes the idea of legions of small donors coming together for a cause, but the policy isn’t just nostalgia for 2008. Despite general objections to Obama’s jobs policy, some Republicans are on board too. Congressman Patrick McHenry (R-NC) has introduced a bill removing the cap on small investors. To protect against scams, his proposed law limits crowd-investors to no more than 10 percent of their income or $10,000, whichever is less.

"With so much difficulty obtaining capital in today’s economy, most business ideas never make it past the dinner table," McHenry says. "This legislation will connect entrepreneurs with everyday investors to help get their businesses off the ground."

Jessica Jackley has been doing that for years, first as founder of Kiva, now at the helm of Profounder, a peer-to-peer investing site that is among the more advanced crowdfunding platforms. Profounder originally tried to offer loans to startups that were repaid based on the company’s success. Regulators put the kibosh on that plan and Profounder is now considering other business models.

Jackley and her cofounder, Dana Mauriello, are frustrated by the current laws and how hard it is to raise money for the smallest of startups.

"Dana and I saw our classmates at Stanford trying to raise money for startups, but they couldn't get it done." Jackley says. "One classmate sent an email asking for $1,000 investments,” but under California law he couldn't accept money from sixty interested investors. Eventually, after legal costs, it cost him $20,000 to raise $35,000."

The demand for this kind of investment exists, especially for social enterprise. When Jackley’s previous company Kiva offered anyone the opportunity to make zero-interest loans to microentrepreneurs in the developing world, they had more lenders than they knew what to do with. Those Kiva donors are already comfortable lending online, with many lending to American businesses through the company’s new Kiva City platform.

Asked to predict what the first wave of crowdfunded businesses will be, Jackley says “I think social enterprises, I think retail. Anything that is a consumer brand that people love and can relate to and feel like they can be a apart of. When there’s a social benefit attached to it, that’s huge.”

Proponents of crowdfunding say fraud isn't as much of a concern as it was in 1934. Sites like eBay have managed to vet users well, creating trust and accountability and displaying good best practices for crowdfunders.

Government regulations are "a very legitimate response to protect investors from getting ripped off” says Antony Bugg-Levine, co-author of "Impact Investing: Transforming How We Make Money While Making a Difference." Countries around the world are reviewing their laws on investing, he says, in large part because investing isn't just about making money, or saving for retirement anymore. Now, investing and social enterprise is a tool for social change.

“We have to think of new ways to unlock capital for the business that can address social challenges, while still protecting investors from bad investments,” he says, predicting that the same new technologies that enable crowdfunding in the first place will also enable fraud protection.

Jackley and White are standing by to prove it. “We’ll actually change the world,” White says. “That’s why we are in this.”

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