Why Start-Ups Need ‘Crowd-Funding’
Are you familiar with “crowd-funding?” You should be. I have been following the progress of new crowd-funding platforms in recent months, and it is now clear that this new financing mechanism can help strapped early-stage ventures, especially social enterprises. In case you’re hearing about crowd-funding for the first time, let me bring you up to speed.
At its core, crowd-funding is a way for people anywhere (“the crowd”) to use the Internet to find and finance endeavors they believe in. It has been used, variously, to raise seed financing for socially responsible start-ups (Launcht), to supply microcredit in the developing world (Kiva), to collect donations (Karma411), to collect campaign contributions (the 2008 Obama campaign) and to collect money for artists from patrons (Kickstarter). These are just a few examples in a growing industry that helps nonprofit organizations and other causes tap the good will of their communities. But the opportunities could be even greater. Thus far, crowd-funding sites have only been able to accept donations, because securities laws prevent them from accepting investment capital. But that could change.
Early on, we financed TerraCycle mostly by winning business-plan competitions. As we grew, we focused on attracting angel investors. While more traditional options worked for us and remain viable, crowd-funded investments would allow entrepreneurs to convert their early social capital into financial capital more efficiently. It’s still evolving, but I think crowd-funding may be poised on the brink of a far-reaching transformation, moving beyond its roots in charitable giving to become a crucial investment engine for for-profit start-ups.
Many crowd-funding platforms would like to enable entrepreneurs to make small stock offerings to the general public, but it’s the Securities Act of 1933 and its registration requirements that prevent this. Specifically, there are restrictions on who can invest and limits on how many investors a company can have before it must start filing reports like a public company.
But if crowd-funding platforms were allowed to solicit investments, a whole new financing mechanism would become available to start-ups. This could have been huge for TerraCycle. With our sustainability-focused business model and our David-vs.-Goliath litigation against a much larger competitor, we generated a lot of early buzz and support. With crowd-funding, we could have turned that support into a grass-roots investment campaign as well.
Plus, if Launcht had been legal and available in 2007, it would have allowed us to take smaller amounts from a larger group of investors. This would have reduced the pressure on us to produce big returns for each investor, because each investor would have had less at risk. It also would have given us access to more people who would have been vested in our success, which would have produced more leads and opened more doors. And it would have allowed TerraCycle’s founders to retain more equity in the company.
Millions of people have already financed projects and nonprofit organizations with crowd-funding donation platforms. Inspired by the phenomenon, small-business owners and other citizens have banded together several months ago to propose a “start-up exemption” to the Securities and Exchange Commission’s registration requirements. The folks at StartupExemption led the way with a proposed framework for the new legislation and they continue to rally support.
Specifically, the bill would allow businesses to raise up to $1 million from an unlimited number of investors from the general public. These investors would not count toward the 500-investor cap the S.E.C. places on private businesses. The S.E.C. would be in control of establishing the specific guidelines to screen out bad actors and would set regulations on the process to hold entrepreneurs, crowd-funding investment platforms, and investors accountable.
I hope you will consider supporting this legislation. It would help start-ups raise investment capital from broader communities, and that would allow entrepreneurs to start more businesses — and wouldn’t that be great for the economy right now?