The Internet is profoundly democratic, lowercase “d.” Anyone with computer access can publish a book, hawk his collection of vintage duck decoys, provide advice on holistic healing.
Crowdfunding, enabled by the Internet, promises as profound a shift: Anyone can become a venture capitalist and anyone can solicit those would-be capitalists to support his startup dreams.
Crowdfunding competes with traditional sources of startup funding, “the keepers of the treasure” as Thom Ruhe of the Kauffman Foundation calls them. The foundation exists to promote entrepreneurship, and Ruhe is vice president of entrepreneurship at the foundation. He says crowdfunding is an innovation that has the potential to change everything.
Traditional sources of financing — “the angel investors, the networks that exist, the venture capitalists, the banking system” — have dominated the business startup system essentially forever. These are the “keepers of the key,” Ruhe says. “They’re the keepers of the treasure, the treasure that an entrepreneur needs to start the company.
“The emergence of crowdfunding is really adding competition to that scenario. And in very general terms, competition is a good thing,” he says. “I don’t mean to sound Pollyannaish when I say this, but it might even up the leverage of power a little bit if entrepreneurs have another option out there.”
In its broadest sense, crowdfunding lets people solicit money for their projects or startups over the Internet, potentially tapping thousands of small funders. Four main kinds of crowdfunding have emerged: charitable, reward, equity and lending-based, also known in some quarters as micro-financing.
Charitable is exactly that: Donors give money to a cause — animal welfare, someone’s independent film — with no expectation of receiving anything but self-regard and maybe a thank-you note in return.
In reward crowdfunding, dominated by the company Kickstarter, the people behind the projects being funded provide tangible rewards tied to giving levels, much like the gifts offered during a public television or radio fundraising drive: a DVD for $10, an invitation to the film premier for $100.
Equity crowdfunding — also known as securities crowdfunding, in which financial supporters buy a stake in the enterprise — is a much more serious business. The bipartisan Jumpstart Our Business Startups Act — JOBS Act — approved by Congress a year ago was designed to help small business gain access to capital.
One of the bill’s provisions would open up equity crowdfunding to a much larger pool of investors, letting small enterprises sell stake in their companies online directly to the public. “For the first time ordinary Americans will be able to go online and invest in entrepreneurs that they believe in,” President Barack Obama said.
The federal Securities & Exchange Commission, however, has failed to write the regulations that would let “non-accredited” investors — those who don’t have a high net worth — buy equity stakes. Until that happens, those non-accredited investors remain shut out of equity crowdfunding.
All four kinds of crowdfunding are alive and well in Arkansas. But the reward crowdfunding (those projects that appear on Kickstarter and Indiegogo) and lending-based crowdfunding (Kiva) are so far the most visible to the casual investor and the most available to the smallest of small businesses. It’s the kind of crowdfunding sought to open a beer tasting room in Little Rock or launch a candy-of-the-month enterprise.
Risks and Rewards
Crowdfunding — at least, equity crowdfunding, the kind that hasn’t yet been opened to the public — has the potential to go profoundly wrong.
“The danger of equity crowdfunding is that you’ll lose your investment,” says Heath Abshure, Arkansas securities commissioner.
“The motivation for the investor — or the funders, I guess we should call them — is much different. With reward or prepayment crowdfunding, you’ll receive, say, a non-financial reward and you’re doing it more for the charitable aspect of helping someone along.”
“With equity crowdfunding, if the only way you can get people to give money to your plan is to promise them a return, and it is the chance of benefiting, the chance of receiving a return or a yield that’s driving that funding, that’s different,” Abshure says. “That makes it an investment.”
And the failure rate of small startups is high.
Abshure says he supports reward crowdfunding. “I’m a big fan of the reward or just the donation-based, but when you change it to equity and when you really structure it as an investment vehicle, it changes the entire thing.”
That kind of crowdfunding, depending on how the SEC ultimately writes the rules, has its own potential for change, says Ruhe of the Kauffman Foundation.
Ruhe points to a recent Kickstarter crowdfunding effort: Zach Braff, an actor best known for his role on TV’s “Scrubs,” is seeking $2 million for a new movie, “Wish I Was Here.” On his project page, Braff says a traditional film financing deal “would have involved making a lot of sacrifices I think would have ultimately hurt the film.”
But maybe, he says, “there is a new way to finance smaller, personal films that didn’t involve signing away all your artistic control.”
So far, 33,171 backers have pledged $2,329,391 with 22 days to go.
Ruhe thinks Braff’s pitch — framing it in terms of artistic freedom — is clever. Call it the “stick-it-to-the-man” campaign, if you will.
“I want to be clear: It’s not like I’m condoning a stick-it-to-the-man strategy for companies. This is, after all, the foundation of entrepreneurship. We are blatantly and happily capitalists,” Ruhe says. “I just thought it was fascinating.
“It’s like an evolution of the medium. I think that the traditional funding ecosystem is going to have to figure it out. They’re democratizing access to startups. They’re democratizing the ability to invest in ideas. It’s no longer the sole purview of those few who control the money.”