Crowdfunding 2.0: Why It Just Might Change the World

by Adam Goyer and Mara Schmid

Over the past year, significant changes in United States law have affected how startups and entrepreneurs are able to raise money for their projects. Adam’s work with companies on the financial and strategy side, and Mara’s work in branding and marketing, have given us an inside look at the future of fundraising. These recent changes are only now beginning to ripple out into the mainstream, but we believe they represent a deep sea change — one that carries with it great promise.

Background

In 2012, President Obama signed the Jumpstart Our Business Startups, or JOBS, Act. The JOBS Act was intended to encourage entrepreneurship and the growth of small businesses by easing and altering some of the regulations around raising money and issuing securities. One of those changes was called Regulation CF, for “crowdfunding,” and it concerned rules and forms for equity crowdfunding in the United States.

Merriam-Webster defines crowdfunding as “the practice of soliciting financial contributions from a large number of people, especially from the online community.” Most people are familiar with crowdfunding via websites like Kickstarter or Indiegogo, where inventors, artists, and businesspeople offer perks like T-shirts or a finished product — say, a new smartwatch or electric bicycle — to people who back their venture. Other sites, like GoFundMe, offer “personal crowdfunding” where people raise money for medical expenses, college funds, and more.

The third kind of crowdfunding, securities crowdfunding or equity crowdfunding, is the least known. Because it is a type of investing, it sounds complicated and confusing to many, but all it means is that in exchange for giving a business or startup some of your money, you get a share of the company — instead of a T-shirt or a product.

If that sounds like normal investing — say, buying shares of Apple or Target, it is indeed very similar. The difference is that with startups, which often bring to the table relatively untested concepts or products, the risk is a lot higher. Traditionally, the United States has heavily regulated such early investing, limiting companies so that they could only solicit funds from the richest Americans (those who had enough wealth to be qualified as “accredited investors”).

The Promise of Reg CF

With Regulation CF and other changes under the JOBS Act, investing in startups is no longer limited to the wealthiest Americans. Anyone is now allowed to invest the greater of either $2,000 or 5% of his or her annual income (or net worth, whichever of those two is less). This change democratizes early-stage investing for both entrepreneurs and would-be investors.

Multiple studies have found that overwhelmingly, venture capital for startups goes to businesses founded and led by white men. When you consider that the wealthiest Americans, those funding these businesses, are also often white men, the systemic implications begin to become more clear. Besides the racial and socioeconomic considerations, it is impossible to measure how the weighting of this bias might limit innovation and diversity in business itself.

By opening investment to “the crowd” (i.e. everyone), any business or idea with enough supporters — of any demographic whatsoever — will be able to raise funding and have a shot at success.

Current Problems

Regulation CF went into effect on May 16, 2016, so it is still very new. But already we see that while it is an exciting change and a step in the right direction, it’s not a panacea. There are some problems with it as it is currently designed.

First and foremost, business are limited to raising no more than one million dollars yearly under Reg CF. For many businesses, this is simply not enough cash for what they need to accomplish. A million dollars is a lot of money, but it doesn’t go as far as it used to. For businesses with heavy research and development costs or products that are expensive to manufacture, Regulation CF may not even come close to raising as much as they will require.

Another issue is that many of the startups currently raising money with Reg CF are ultra high risk/high reward ideas hoping to be the next Uber or Airbnb. Realistically, most won’t be, and those who have a shot at it will likely need 5–8 years to reach any real level of success. This means investors must be prepared for their money to be tied up, without seeing any return, for a number of years. If a company does end up being wildly successful and building over $25 million in assets, this triggers the need for additional filing and compliance from which companies using Reg CF are normally exempt.

A third problem that is affecting the rate at which Reg CF is used and adopted is that currently investors have no way to see crowdfunding securities in their investment portfolios. If you’ve ever owned stock and logged onto your Charles Schwab or eTrade account to check how it was doing, you know how reassuring it is to have a way to see your investment and manage it. Currently, there is no process to give people who invest in startups via crowdfunding this ability.

Possible Solutions

Legislation to improve Reg CF is already kicking around Capitol Hill — has, in fact, been kicking around Capitol Hill since even before Reg CF went into effect. H.R.4855, or the “Fix Crowdfunding Act”, has gone through a few different versions, and is currently in the Senate after having passed in the House.

In the meantime, the private sector is taking its own steps to address some of the issues. Crowdfunding platform SeedInvest has published a public note asking for input from the crowd on a proposed security structure they are considering for Reg CF. Monarch Bay Securities, an investment banking firm where Adam is a Registered Representative, is working with Folio Investing to develop a way for investors to have their crowdfunding assets show in their online accounts.

A New Way to Use Reg CF

While these solutions are worked out, we see another possibility for Reg CF. Through Adam’s work with Monarch Bay and our work at Blak Box Group, a digital agency that helps companies brand and market their offerings, we are beginning to encounter situations where profitable companies that already have cash flow but need an infusion for a new location or division, are able to use Regulation CF to raise this money. In this use of Reg CF, investors can be paid on revenue if the business is successful, whether or not there’s ever liquidation or sale of the company. Instead of waiting years to see if a startup becomes a big smash, an investor can buy a small share of, say, a new restaurant location, knowing that previous restaurants in the chain are already doing well.

The Future, Co-created

Regardless of the details, it seems evident that crowdfunding is here to stay, and specifically the kind of crowdfunding that creates more fair and democratic investment opportunities for all Americans. These opportunities will not come without risk, and current limitations of equity crowdfunding implementation may increase those risks unnecessarily. Nonetheless, it’s clear that people on both sides of the equation — investors and entrepreneurs — see the benefit of this new paradigm and are committed to finding a way to make it thrive. Agencies and businesses from various aspects of this space — online brokerage firms like Folio, investment banks like Monarch Bay, and crowdfunding platforms like SeedInvest and Fundable — are working together on the problems surrounding Reg CF and other fundraising pathways, and it’s heartening to see that the private sector can and will step up to find creative solutions while at the same time working with the SEC to refine and improve regulations.

At its heart, crowdfunding is co-creation. Someone with a great idea presents it to the crowd and asks if they will help make it possible. This is a beautiful and powerful process, one that may hold many solutions to the problems of our modern world. We’ve seen hints of this potential in the best Kickstarter campaigns, where some products have been wildly embraced by the public that couldn’t get a hint of interest from traditional angel investors. We’ve seen hints of it on GoFundMe, where people facing difficult times have seen their communities come together to help out. Equity crowdfunding may be just the next great iteration.