Crowdfunding: An Old Idea with Newfound Potential

 

Takeaway

  • The 2012 JOBS Act made it easier for small investor groups to efficiently raise large pools of money online
  • Governments around the world are racing to regulate crowdfunding, due to the high-risk nature of these investments
  • In October the SEC proposed new rules to ease online fundraising for startups and protect investors from fraud

Crowdfunding is a hot topic in the financial world, and like all hot topics there’s a lot of opportunity if you understand the facts, and a lot of noise out there based on perceptions rather than reality. This is the first article in a multi-part series about crowdfunding’s evolving role in the startup community.

The concept of crowdfunding has been around for a long time. In 1884 New York World newspaper publisher Joseph Pulitzer asked his readers to donate money toward the pedestal for the Statue of Liberty, which had run out of funds. The effort raised more than $100,000 in six months from 125,000 people.

A more recent example is the proliferation of international micro-credit lending. These programs extend small loans (typically measured in hundreds of U.S. dollars) to borrowers who lack classic banking requirements like collateral, savings, employment histories, and credit ratings. Grameen Bank is a pioneer in this field and reports that repayment rates are above 95%.

Fast forward both of these examples to the first-world economies of today, and you have the ability to efficiently raise large pools of money from many small investors brought together by the Internet. Organizations around the world are implementing versions of crowdfunding websites, and their governments are racing to catch up on the regulatory front given the high-risk nature of these investments being readily available on public websites.

The United States has taken a large step forward in making crowdfunding a reality through the 2012 bipartisan JOBS Act. Two big changes are brought about by this act, compared to the traditional model of raising money from friends, family and angels.

First, it allows non-publically traded companies to use the Internet to raise investment capital up to $1 million per year with less formal paperwork, and hence less expense. The other change lowered the accreditation hurdle investors need to meet, allowing those earning less than $100,000 invest up to 5 percent of their income.

On October 23, 2013, the SEC unanimously approved moving forward on the crowdfunding bill, a required step before the revised approach can be formally implemented in the U.S. The SEC explained that its goals are to ease online fundraising for small companies while maintaining fraud protection for investors.

Obviously there is a lot of opportunity for entrepreneurs and investors in this new approach. In future posts I’ll cover the popular sites for crowdfunding, what the investment approaches and instruments look like, and some of the pluses and minuses for entrepreneurs and investors associated with crowdfunding.

For more background information, check out these articles from CNBC and Inc.

Dr. Rob Adams teaches in the McCombs MBA program and is the director of Texas Venture Labs. The above article originally appeared on his blog.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

About The Author

Rob Adams

Director, Texas Venture Labs, McCombs School of Business

Rob Adams is an active investor, author, consultant and on the faculty of the Management Department at the University of Texas at Austin’s McCombs...

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