News Column

Crowdfunding: A New Way of Investing Opens to Businesses

April 18, 2012

Rick Romell

Crowdfunding

Crowdfunding, a Web-powered money-raising technique pioneered by charities and arts projects, is moving into the world of business.

It soon will emerge as a potential vehicle to finance small firms, a prospect that interests people such as Juli Kaufmann, one of the founders of Fund Milwaukee, a recently organized group seeking to improve the community through local investment.

"This is an incredible new opportunity that we otherwise didn't have access to," Kaufmann said last week.

Crowdfunding is the buzz-generating provision of a piece of legislation passed by Congress in a rare show of bipartisan spirit and signed by President Barack Obama on April 5.

Dubbed the JOBS, or Jumpstart Our Business Start-ups, Act, the new law eases restrictions on how small firms raise money.

They'll be able to go public without clearing all the usual regulatory hurdles, and they'll be able to sell equity to "nonaccredited" (read, nonwealthy) investors.

That typically has been forbidden, and some people think it should remain that way. But others see a new world of finance opening that will give ordinary folks a chance to buy into promising opportunities and provide capital to firms that are too small or too plain to interest angels and venture capitalists.

In crowdfunding, many people make relatively small investments that collectively amount to serious money.

The new law limits how much any one investor can funnel to any one company. For someone making less than $100,000 a year -- that's four out of five American households -- the cap is $5,000.

Some worried

Still, many observers worry that these loosely regulated investments will breed fraud.

The North American Securities Administrators Association, a 93-year-old group of state and provincial securities officials, called the JOBS Act "an investor protection disaster waiting to happen."

"Investors need to prepare themselves to be bombarded with all manner of offerings and sales pitches," association president Jack Herstein, assistant director of the Nebraska Bureau of Securities, said in a statement after the bill signing.

" Congress has just released every huckster, scam artist, and small-business owner and salesman onto the Internet."

And Roberta Karmel, a Brooklyn Law School professor and a member of the Securities and Exchange Commission under President Jimmy Carter, said the new law ignores the lessons of history.

In 1980, Congress passed legislation easing regulations on capital formation by small businesses. Small firms raising seed money were allowed to advertise and sell securities to basically anyone without having to register with the SEC.

Two decades later, the SEC clamped down. Stock issued under the eased regulations was being resold in over-the-counter markets, at times in fraudulent schemes. The SEC reacted by banning general advertisement of unregistered securities.

Karmel sees parallels to crowdfunding.

"This is just going to lead to some kind of bubble or there will be fraudulent offerings, and then Congress will say we need more regulation," she said.

Others aren't so worried.

"I personally have more confidence in the intelligence of the American public that we don't need to be so paternalistic," said Scott Shane, professor of entrepreneurial studies at Case Western Reserve University in Cleveland, Ohio.

The limits on how much can be invested offer protection, and would-be investors can be reminded of the need to investigate before offering their money, he said.

People should invest no more than they can afford to lose, because these will tend to be high-risk situations, said Dan Olszewski, director of the Weinert Center for Entrepreneurship at the University of Wisconsin-Madison.

He also sees promise in crowdfunding.

"It definitely has a lot of potential for certain types of start-ups that need a limited amount of investment dollars to launch their business," Olszewski said.

Local benefit

One area that stands to benefit is the type of investing Kaufmann and the others at Fund Milwaukee want to do -- financing local businesses that they believe can enhance the community as well as deliver a return.

"The biggest winners out of this will be Main Street companies," said Amy Cortese, author of "Locavesting: The Revolution in Local Investing and How to Profit From It."

"If you're a high-tech start-up doing an iPhone app or the next social network, you have no dearth of investors willing to put up money for you," Cortese said. "But it's much harder for your bread-and-butter type of small businesses -- the ones that may not be in the most glamorous or sexy businesses but nonetheless have very good prospects, are part of the fabric of their communities."

Fund Milwaukee has backed what it believes is one such business so far -- ice cream-maker Purple Door. Eight of the group's 18 members lent money to Purple Door to help it buy equipment and open a retail store in a Fifth Ward building Kaufmann developed.

Other businesses, including a brewer and a food processor, have approached Fund Milwaukee about investing, Kaufmann said.

Whether the group branches into crowdfunding isn't certain, but Kaufmann for one is enthusiastic about its potential to support community-oriented investment.

"People are very generous in Milwaukee and really want to see Milwaukee be a better place," she said.

And crowdfunding, she said, offers a sort of do-it-yourself avenue of finance that aligns well with many people's ideals.

"It's a reaction in some ways to those who are disappointed with Wall Street and what financial markets are doing," Kaufmann said. "We see the damage, but we don't understand how we can make a difference, and this is kind of creating the path to taking your finances back into your own hands and using the power of your own money to have the impact you want to see directly in your community."

Whether that's the result, or whether crowdfunding spawns a new round of pump-and-dump schemes and other fraud, won't be known for a while. The SEC has nine months to work on rules covering the mechanics of the new law.

Then the doors will open.



Source: (c)2012 the Milwaukee Journal Sentinel. Distributed by MCT Information Services


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