Crowdfunding may be kickstarting startups soon

By Lou Carlozo, Reuters

CHICAGO -- Artists are not renowned for financial savvy, but their success in raising money on the Internet through donations to crowdfunding websites like Kickstarter and Indiegogo could lead the way for a new class of investing. Soon investors will be able to pile money into startups through such sites with the hope of getting more than a lousy t-shirt in return.

Before April 5, U.S. regulators only allowed donation-based crowdfunding projects, which raise money from the general public via the Web.

While businesses have used such sites to get working capital, they have generally taken preorders for yet-to-be-created merchandise instead of selling equity. But new possibilities are opening up because of the Jumpstart Our Business Startups, or JOBS, Act, which President Obama signed into law last month.

The act provides crowdfunded businesses and investors with exemptions to the Securities Act of 1933, which prohibited people with a net worth below $1 million from investing in private companies. For the first time, businesses can advertise for investors without filing the standard disclosures required of companies with more than $1 billion in revenue.

The U.S. Securities and Exchange Commission still has 270 days from the JOBS Act signing to review and make final changes to its regulation, but if the statutes stay in effect as-is, just about anyone will be able to invest in a startup or small company.

"What's new is being able to offer equity in return," says Slava Rubin, chief executive officer and co-founder of major crowdfunding site Indiegogo.

"And it's just the beginning," said Rubin, whose site has helped fund more than 5,000 projects since he unveiled it at the Sundance Film Festival in January 2008. "We're talking about a law that hasn't changed in 79 years."

So is a crowdfunded investment opportunity any different from pouring cash into junk bonds or penny stocks? It's impossible to say, since the first crowdfunded investment offerings have not hit cyberspace just yet.

But they will soon enough. Since the beginning of May, at least two new investment-oriented crowdfunding initiatives have been announced -- a partnership between EarlyShares.com and Navocate, and one by the US Crowdfunding Exchange LLC.

Getting fleeced?
Critics of the JOBS Act worry that small investors will get fleeced.

"Institutional investors can make choices based on the information they have," says James Allen, head of capital markets policy for the CFA Institute, a global nonprofit organization of investment professionals. "It's the mom-and-pop investors who are the bigger concern in this case, particularly the people on fixed incomes, the retirees."

Allen says these people are vulnerable because under the JOBS Act, many investor protections (some put into place after the Enron debacle) have been bypassed.

Others, including Brookings Institution senior fellow Robert Pozen, also say the act will open a new avenue for stock scams and the highly speculative investing that gives birth to bubbles. Meanwhile, state regulators fear a Wild West mentality where unscrupulous wheeler-dealers, now able to bypass any disclosure requirements, could siphon millions from naive investors.

But supporters of the JOBS Act say the new legislation creates a sort of social media trading pit where entrepreneurs can now give everyday investors the possibility of getting in on the next Google Inc or Microsoft Corp.

Others who back the new law's crowdfunding provisions say it will open up investor dollars to creating, as the act's name suggests, new jobs. Even Allen acknowledges that crowdfunding comes at a time when "banks aren't lending to small businesses, or much of anything. They don't have much of an incentive."

New resource
Members of the National Association for the Self-Employed view crowdfunding as a vital new resource for startups and job creation.

"This will really open the floodgates to a whole new arena of entrepreneurs who are trying to help other entrepreneurs finance their dreams," says NASE CEO Kristie Arslan. "The great thing about crowdfunding is that it allows people to choose; you're putting your business idea out there and asking people to invest in you and your idea. The good ideas will hopefully rise to the top."

At least the money looks good.

Indiegogo now raises "millions of dollars a month" worldwide, Rubin says.

And Kickstarter, a three-year-old major crowdfunding service, went from $1 million pledged per month in March 2009 to $7 million in March 2011. As of May 2012, more than $200 million has been pledged to more than 22,000 successfully funded creative projects, according to Kickstarter spokesman Justin Kazmark.

Among them was "Blue Like Jazz," which smashed previous film crowdfunding efforts by more than $145,000. The movie adaptation of Donald Miller's bestselling memoir came out in theaters nationwide last month to glowing reviews. Director Steve Taylor says that last year, the project seemed doomed because a financial backer walked out hours before production was to start.

Then two of Miller's fans jumped in on Kickstarter and raised $346,000 in a few months. For their trouble, all the funders got thank-you phone calls from Taylor (it took him about a year to call back all 4,500 people), and those who gave at higher levels were offered bigger perks, including a cameo role in the film.

Will Taylor fund his next film in a similar way? He says he would not rule it out. But if he markets it as an investment opportunity, those who fork over cash will want more than a simple "thank you" -- unless it's written on the back of a check.

Jeff Applegate, Morgan Stanley Smith Barney CIO, discusses market volatility, European debt worries, the Facebook fallout, global growth concerns and where Wall Street goes from here.

Copyright 2011 Thomson Reuters. Click for restrictions.

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