Crowdfunding: Where things stand one year later
FORTUNE — It’s been exactly one year since President Obama signed the JOBS Act into law. After passing with flying colors in the House and Senate, the President called the new legislation a “potential game changer” for its ability to alter the fundraising landscape for both startups and small businesses. Of the law’s many facets, the section pertaining to crowdfunding has gotten the most attention from both legislators and media. But after 12 months of waiting, crowdfunding proponents have had little to cheer. The crowdfunding element of the law continues to sit in legislative limbo.
The JOBS Act will allow ordinary investors the opportunity to invest in small or early stage startups in exchange for company equity. Currently, only individuals who meet certain wealth or income requirements are allowed to invest in private companies in exchange for ownership. Crowdfunding platforms have so far survived on a perks-and-gifts model, meaning donors are rewarded with small gifts or products, but not stock. The Securities and Exchange Commission has been tasked with creating the rules surrounding the proposed new form of equity-based crowdfunding, but a January 1 deadline established by President Obama has come and gone without any word from the SEC.
Equity-based crowdfunding often elicits more questions than it does answers. Here’s a look at where we stand as the JOBS Act celebrates its first birthday.
What is known:
The current perks-based crowdfunding model has been wildly successful. Kickstarter, the most well-known crowdfunding site in the industry, raised nearly $275 million in 2012 while funding over 18,000 projects. Indiegogo, another top platform and Kickstarter’s closest competitor, doesn’t share total fundraising figures, but campaigns did raise an average of 20% more money in 2012 than they did the previous year. The best part of the perks-based model — nearly any idea can become a reality with enough of a niche following. On Indiegogo, a cat café in London (yes, a café for people to bring their cats) raised over $165,000 in February.
Kickstarter will not participate in equity crowdfunding. Despite its position as an industry leader, Kickstarter has been adamant that it will forego any type of equity-based crowdfunding regardless of what the rules look like. The founders haven’t talked much about the reason behind their decision, but it seems simple: If it ain’t broke, don’t fix it. Kickstarter specializes in campaigns focused on the arts — music, theatre, dance, and fashion — and has no interest in expanding into other areas. By leaving equity-based crowdfunding alone, Kickstarter does open up the playing field to other competitors who are willing to take the chance on a new form of investing.
Equity-based crowdfunding has caught people’s attention. In January, the North American Securities Administrators Association began investigating the influx of crowdfunding domains that have cropped up following the signing of the JOBS Act. State securities officials found over 9,400 domains containing the term “crowdfund,” nearly 10 times more than 2011. The list ranges anywhere from latincrowdfund.com to petcrowdfunding.org to rarecoincrowdfunding.com. There’s a good chance that many of the sites are owned by squatters — people holding the domain name in hopes they can sell it off at a later date — but the message remains clear: People are anticipating crowdfunding to take off.
Equity crowdfunding has had success abroad. Equity-based platforms already exist in both Australia and the United Kingdom. The Australian Small Scale Offering Board, the most successful equity-based platform in the country, allows campaigns to raise up to $5 million in capital but does have stricter guidelines than what we will likely see in the U.S. (The JOBS Act stipulates that U.S. campaigns will be limited to $1 million per year.) In Italy, CONSOB — the Italian equivalent of the SEC — pushed down their equity-based crowdfunding rules earlier this week, meaning it’s likely the Italians will have a system up and running much sooner than we will.
Mary Jo White seems motivated. The new SEC Chair has been public about making the JOBS Act a priority for her new department, which should go a long way to appease restless crowdfunding proponents. Former SEC Chair, Mary Schapiro, was believed to be an opponent of the law.
What is unknown:
When will the SEC rules come down the pipeline? No one can offer much more than speculation as the SEC has kept a tight lid on the entire process. Numerous crowdfunding players, including Indiegogo, RocketHub, and Crowdfund Capital Advisors, have made repeated trips to Washington to present to rule-makers and answer their questions. Most believe there will be rules by the end of 2013 at the latest, but there’s always a possibility that the SEC could take much, much longer.
How will investors and entrepreneurs communicate? This will depend on what the SEC rules stipulate, but the interaction between investors and campaigners at the moment appears undefined. Will entrepreneurs be required to post monthly updates or host conference calls? Will investors have voting privileges like they do when owning stock in a publicly traded company? “I absolutely won’t invest in something unless I have sat down with the entrepreneur,” Kevin Rose, a general partner at Google Ventures (GOOG), told Fortune back in February. “That’s obviously extremely difficult to do online, so if anything I’d just be cautious.”
How will equity crowdfunding change the traditional funding infrastructure? With more entrepreneurs able to gather seed funding from the crowd, it allows each rung of the traditional investor ladder to move further along in the process. Angels will still have the opportunity to be aggressive if they want, but with more early-stage startups getting off the ground without angel backing, established investors and venture capitalists will have the ability to pick from a more robust list of opportunities. The seed round of funding will be taken care of (in theory), leaving VCs to focus more on growth funding for those startups that show promise.