In 2008, presidential candidate Barack Obama realized he could raise a lot more money from millions of individual donors on the Internet making small contributions than he could by begging hundreds of traditional party big donors to write big checks. That discovery revolutionized American politics, and something similar may be about to happen to American business.
That's thanks to new rules released by the Securities and Exchange Commission Wednesday to allow "crowdfunding" of new companies, mostly through online fundraising efforts by start-ups. The concept, which was given the legal go-ahead under last year's JOBS Act, could change the whole concept of start-up company financing.
Today, entrepreneurs have to go hat in hand to a few large financial institutions and venture capital firms that act as the gatekeepers of capital and decide which companies get financing and which do not. Under the new model, nascent companies would be able to sell equity stakes online to a potential pool of millions of investors who believe in the company's product or idea. And if they have a hot enough idea, they can skip the VC office beg-a-thons altogether, giving average people a chance to get in on hot new offerings and entrepreneurs a chance to hold on to more equity in their companies.
That sounds great in theory, but in practice many observers are worried about scam artists and fraudsters taking advantage of the new rules to churn out bogus offerings with hot-sounding names, and take advantage as well of naïve investors on the Internet. So the SEC has been wrestling with how to allow the new funding practice without encouraging fraud.
(Read more: CNBC Explains: Crowdfunding)
The answer came Wednesday, as the commission outlined a proposal to subject crowdfunding to strict investment caps—to limit the exposure of individual investors to any one investment, and to limit the amount that companies would be able to raise through crowdfunding—meaning that at first, financing entirely by crowdfunding may only be useful for the smallest of companies or those in the earliest start-up stages.