by Sherwood Neiss, principal of Crowdfund Capital Advisors
This is a continuation of Part 1, in which Sherwood addresses the earliest stages of crowdinvesting’s development.
Welcome to the Internet Age
The changes in how people communicate made the time ripe for crowdinvesting. In the past decade or so, people have largely moved their conversations and friendships online. We communicate with our friends and loved ones on the Internet and via social media, and doing so allows for easier access to crowds. Instead of having to make dozens of phone calls to tell your friends that you’re starting a new venture, now you can spend ten seconds updating your Facebook profile and let all your contacts know at once. People spend an increasing amount of their time online, and that includes time they spend shopping, investing, and making other business-related decisions. Therefore, it just makes sense to introduce the means for entrepreneurs and small businesses to raise funds online and for individual investors to locate such investment opportunities via their online social networks.
Web 3.0 – Merging the Social Network (Web 2.0) with Seed Financing
After the financial collapse of 2008, small business funding dried up. If you were a small business owner or entrepreneur and went into a bank for a loan, the bank would require three years of financial statements, as well as enough assets to back your loan. If you were trying to fund a startup, meeting these requirements was impossible. Credit card interest rates were raised to extremes, and credit limits were slashed. With traditional financing out of reach and access to private equity and venture capital extremely limited, something had to give for small businesses and startups.
But after 2008, many people lost trust in the traditional financial systems. They stopped putting blind faith in big companies, big banks, and Wall Street. They still wanted to invest their money in businesses (it’s what Americans do!), but they didn’t want the people responsible for the global meltdown to take a cut of the pie. This is why we created the framework to legalize crowdinvesting.
It isn’t new by an means and its tenets are easy to understand. The microfinance Grameen Bank founded by Nobel-peace prizewinner Mohammed Yunis supplied small (mirco) loans to developing world entrepreneurs who have trouble raising capital. Kiva took the practice and extended it to the crowd, allowing entrepreneurs to put their pitches up on the web for the community to decide who to fund. Since Kiva began, it has funded over $300 million in loans with a 98 percent repayment rate — far better than credit card companies have in the developed world.
Why Crowdinvesting was Illegal
This forced us to ponder, “If we can donate to artistic projects all over the United States on crowdfunding platforms like Kickstarter and we can lend money to entrepreneurs in other countries, why can’t we use the web and social media to raise money for U.S. small businesses we know and entrepreneurs we believe in and give people a slice of equity in return?” When we went to talk with a securities attorney, he politely explained that what we planned to do was illegal based on the Securities Acts of 1933 and 1934. He said that we couldn’t publicly solicit the sale of private shares to unaccredited investors. He continued by saying that to change this law would require an act of Congress.
And that’s what we delivered as part of the JOBS Act in 460 days. Not because we were selfish lobbyists (we aren’t – we are successful entrepreneurs that couldn’t raise capital under the current regulatory system) but because it was exactly the right thing to do. It didn’t make sense that laws written 77 years ago (when the majority of Americans didn’t have a telephone!) should govern the sale of securities in the age of the social web. We really believed then, and still believe today, that crowdinvesting is Web 3.0: the social web + capital formation.
One of the biggest changes the JOBS Act created was lifting the restriction on soliciting unaccredited investors to purchase stock. This means that companies that use crowdinvesting to raise capital are legally able to solicit people of all net worths and income levels to purchase their shares. You can’t solicit anyone and everyone, though. You have to follow SEC regulations that require you to directly solicit only people who are members of your social networks, and to do so by sending out notices that drive people to the online funding portal hosting your campaign to learn the details of the investment opportunity.
The JOBS Act spells out, among other things:
* The maximum dollars a business or entrepreneur can seek via crowdfinvesting, which is $1 million per year.
* The maximum amount an individual can invest via crowdfunded ventures in a year, which may be a flat $2,000, 5 percent of the individual’s annual income or net worth, or 10 percent of the individual’s annual income or net worth. The limit depends on the person’s specific finances.
* The means by which a company may seek investments and an individual may make them, which is via SEC-registered online funding portals.
* Other parameters that seek to promote the business sector while preventing fraud and protecting the investor
Crowdinvesting is essentially creating a new set of investors: micro-angel investors. Before the JOBS Act, accepting $100 from a small investor was way too complicated to have been worth it (the regulations just didn’t allow for it). Now, a business owner will have a platform for raising funds in such increments, and every $100 or $500 or $1,000 investment can have a big impact on that business’s success.
With the advent of crowdinvesting in 2013, the average small investor will be able to sit in her living room anywhere in the world, study 20 different pitches from 20 different entrepreneurs or small business owners, decide which of them make sense for her, and fund them with the click of a mouse. Social media will allow her to critique a pitch along with any other potential investors prior to funding. Issuers’ answers will either build credibility and trust or thwart their attempts to hit 100% of their funding target; unless 100% of the funding target is hit, no money is transferred and it goes from the 3rd party escrow agent back to the investors. But if a project is funded, the investor can feel assured that her funds are directly supporting the individual making the pitch — not a multinational financial conglomerate that couldn’t care less about the $100 or $500 or whatever amount she’s investing.
Sherwood Neiss is one of the principals of Crowdfund Capital Advisors (CCA), founded the crowdfund investing movement in the United States, lobbied for its passage, and wrote the framework signed into law by President Obama. He and Jason Best are both Inc500 entrepreneurs and understand how to incubate ideas, mentor them, and match funding to winning ones. Their upcoming book, “Web 3.0 – How Crowdfund Investing will Transform Global Communities Locally” will be released in mid-2013.