The Senate has a plan to legalize crowdfunding for startups by making sure online fundraising platforms hold companies accountable.
After a fit, a start and a dose of whiplash, legislation permitting startups to raise money through online crowdfunding is moving through Congress. The House has now passed two bills, including the Jobs Act this week, that would overturn a 70-year-old ban on small companies asking the general public for seed money.
A few days ago, the Senate began to catch up, releasing its own plan. The result is a bipartisan bill called the Crowdfund Act. If it passes, it could transform how companies get off the ground. One of these versions is likely to pass, but don't expect selling stock online to be as easy as registering your indie film project on Kickstarter.
Current anti-fraud rules forbid people who earn less than $200,000 a year, or who aren't millionaires, to invest in startups. But with the rise of crowdfunding platforms—Kickstarter just funneled more than $3 million to a video game project—lawmakers want to harness the power and money of the little guy to generate jobs and spark new businesses.
"In America, you can gamble all of your money at a casino and you can donate to countless charities around the world, but it's nearly impossible for most people to invest $1 of seed money into someone else's new business," Senator Scott Brown (R-Massachusetts) said in a statement. "This makes no sense, especially in the Internet era where everyday we see new ideas, programs and social networks take off."
The Senate has been stuck debating how to open up crowdfunding while keeping investors safe from fraud. There are also concerns about ensuring that state regulators don’t revolt at the idea of millions of people making many small investments in tiny businesses, which creates a lot of transactions to oversee.
Sen. Merkley says this latest compromise bill "protects those investors and sets fair rules for the road." Leaders at the federal Securities and Exchange Commission have raised concerns that the changes in the law will leave investors vulnerable to scams, just as there is little recourse for Kickstarter users if a project they’ve backed fails to come through.
"The momentum has definitely been toward more investor protections," says Freeman White, founder of the crowdfunding platform Launcht. "The most important thing is we’re not going to get any viable [crowdfunding] industry if investors are scared.”
Those investor protections may seem like are red tape to some, but they are vital architecture for a new industry:
- Individuals earning $100,000 or less a year can invest up to $2,000 or 5 percent of their annual income—whichever is greater.
- Individuals earning more than $100,000 a year can invest up to 10 percent of their income or $100,000—whichever is less.
- Companies are capped at $1,000,000 in crowdfunded investment raised annually. Crowdfunding must take place through an intermediary like IndieGoGo, Launcht, or Kickstarter.
- It's all or nothing. If a company doesn't achieve their goal, they won't get any of the money, just like on Kickstarter now. \n
White is eagerly awaiting a change in the law so he can start accepting equity investments through his website. He's also been advising legislators on how to craft a law that protects investors and enables entrepreneurs at the same time.
Under the Senate bill, Crowdfunding sites will have to perform background checks, collect business plans, and verify what companies plan to do with the crowd-raised money. Funding websites will have to file each offering with their state regulator and the SEC. They become something like a broker-lite, with most of the responsibility and most of the liability of conventional stockbroker.
"From our standpoint that’s a burden, but we’ll just pass that [vetting information] through as a value-added [element] to customers however we price our product," White says.
The SEC gets some new responsibilities, too. Under the law, the agency would be required to keep a close eye on the sector for a year and report its findings to the Senate Banking Committee. A previous worry was that the SEC wouldn’t have time to devote to regulating this and a free-for-all would result—so this law locks them into paying attention, which is at least part of the reason why the SEC is calling for calm and caution before any final vote.
There's still more haggling to be done, but whichever version becomes law is sure to put a lot more hoops in front of a company selling stock online than musicians financing an album currently face on Kickstarter—which makes sense when you’re talking about actually buying a part of a company. Kickstarter is almost certainly going to sit out the equity fundraising game because they're doing so well just funding projects.
But sites like IndieGoGo, Launcht, RocketHub or dozens of others will jump in. They will be required to run potential businesses through a vetting process that is still far lighter and cheaper than any other public offering or capital raising, even if it is still somewhat burdensome. It should be. This is business—and people's investments—after all.
So expect these websites to become the gatekeepers of crowdfunding, and the shepherds of fresh startups toward new pastures of capital. Expect the sites to make big bucks—and maybe suffer big legal costs.