Cut the Red Tape on Crowdfunding

In America and around the world, aspiring entrepreneurs are meeting their colleagues and their mentors in official and unofficial sessions of Global Entrepreneurship Week. Created in 2007 by the Kansas City-based Kauffman Foundation and British organizations, Global Entrepreneurship Week, as stated on its website, “inspires people everywhere through local, national and global activities designed to help them explore their potential as self-starters and innovators.”

And this year, enabling entrepreneurship through crowdfunding will be a huge focus. To coincide with Global Entrepreneurship Week’s events, the recently formed Crowdfund Intermediary Regulatory Advocates (CFIRA) is having its 2nd Annual Regulatory and Advocacy Summit on Capitol Hill tomorrow, November 21. The event will be held in room 902 of the Hart Senate Office Building, and to register for free, go here.

At the summit at 11:45 a.m., I will speak on my new paper just published by the Competitive Enterprise Institute entitled, “Declaration of Crowdfunding Independence: Finance of the People, by the People, and for the People.”

Key points of my report include:

  • Technology did not create crowdfunding, but it has widely broadened the size of the crowds and increased the potential of both charitable and entrepreneurial ventures to find funding.
  • Crowdfunding has positive effects on job growth, revenue for entrepreneurs, and follow-on interest from institutional investors. Firms that met their goals in crowdfunding campaigns hired, on average, two new employees by the end of the campaign. This is all the more remarkable considering that the firms had, on average, only one or two employees before the crowdfunding campaigns began.
  • The most potential comes from equity (ownership interest) and debt (specific rate of return)-based crowdfunding, both of which are either banned or heavily restricted in the United States due to arcane securities laws.
  • Due to fear of running afoul of arcane or vague SEC rules, there is frequently a de facto “millionaires only” rule for investment in new business that limits entrepreneurs’ capital-raising ability and deprives average investors the opportunity to grow wealthy through early-stage investment in a company.
  • While the U.S. leads the world in crowdfunding campaigns on popular sites like Kickstarter and IndieGogo, these campaigns are overwhelmingly donations- and rewards-based. The donors get nothing more than recognition, souvenirs like T-shirts, and or a sample of the product produced.
  • The Jumpstart Our Business Startups (JOBS) Act of 2012 was supposed to alleviate some of those problems, but the SEC has yet to implement provisions to allow crowdfunding offers of $1 million or less.

In the report, I tell the fascinating story of how 20th century entrepreneur Henry Ford used crowdfunding to launch the Ford Motor Company. He offered friends, family members, or acquaintances a return on their initial investment, an arrangement that gave Ford the capital he needed to start his business.

But the report reveals that today, Ford would not be able to make that offer unless those investors “met a strict definition of ‘pre-existing’ business relationships under federal and state securities laws or had substantial wealth to meet requirements of the Securities and Exchange Commission for more lightly regulated investment.”
That’s because offering a share of profits in that way would be considered a “security” under federal law, which would make new entrepreneurs contend with the same amount of red tape that Fortune 500 companies face.

“Crowdfunding essentially involves raising money from a crowd of ordinary people without going through a ‘middleman,’ like a major stock exchange or financial institution. Yet such capital raising in the age of the app is being stalled by rules and regulations that came into place before most homes had telephones,” I write. “As a result, crowdfunding’s potential of creating jobs and increasing income mobility is being held back as entrepreneurs struggle with mounds of red tape from old securities laws.”

The paper concludes by calling for bipartisan reform to liberalize crowdfunding, some of which has already cleared House committees but gone nowhere in the Senate. So, Happy Global Entrepreneurship Week, and let’s make the world more entrepreneur-friendly by cutting the red tape that has a choke hold around crowdfunding.