The Future of Crowdfunding

This past weekend, crowdfunding pioneer ProFounder.com shut down. Hopes has been high for ProFounder, which set out to help entrepreneurs and small businesses raise money from their friends, family, customers and community. One of its founders, Jessica Jackley, was a cofounder of Kiva.org, the wildly popular microfinance site that has raised hundreds of millions of dollars for micro-entrepreneurs throughout the world since it launched in 2004. Could ProFounder do the same for the many entrepreneurs and small businesses held back by a lack of capital in the U.S.?

In its first six months, ProFounder raised more than half a million dollars from 302 investors for 18 companies, including a Hawaiian "shave ice" shop and an electric motorcycle maker. Sadly, Jackley and cofounder Dana Mauriello, who met at Stanford Business School, found that U.S. securities laws made it difficult for them to proceed. Despite their best efforts to comply with state and federal regulations, they drew the ire of the California regulators, who issued a cease & desist order in August. A message on their web site explains:

Despite our progress, the current regulatory environment prevents us from pursuing the innovations we feel would be most valuable to our customers, and we’ve made the decision to shut down the company.

Observers pointed out the irony that, just a week before ProFounder's demise, the crowdfunding world hit a major milestone: two separate deals raised more than $1 million each. In a Kickstarter campaign ended on Feb. 11th, Elevation Lab raised just under $1.5 million for a new docking device for the iPhone, while Double Fine Adventure, an adventure game, is poised to blow past $2 million with more than two weeks to go.

Uncle Clay's House of Pure Aloha raised money on ProFounder 

Crowdfunding is clearly striking a chord. On Kickstarter, people are pledging more than $2 million a week to projects they support—a figure approaching the entire annual operating budget for the National Endowment for the Arts!

But ProFounder was different. Site such as Kickstarter and Indiegogo raise money mainly for artsy projects like documentary films, music CDs, and computer games. Small businesses have been turning to these sites more and more with some success—La Casa Azul, a bookstore in East Harlem, raised nearly $40,000 on Indiegogo to open a bookstore that would cater to the Latino community there. But it's not always a good fit.

ProFounder, in contrast, was designed for small business entrepreneurs.

The other main difference is that Kickstarter, Indiegogo and their ilk raise money from supporters with no expectation of a financial return. In other words, people donate money to projects they want to support in return for an in-kind reward, like a CD, a t-shirt or a credit in a film. It's arts patronage in the digital age.

Meanwhile, on Kiva.org, the microfinance site Jackley co-founded, loans are paid back (the site has a 99% repayment rate), but without interest.

There's more than altruism going on. If a financial return were introduced, these transactions would become securities subject to federal and state securities regulations. And those regulations make it illegal for privately-owned businesses to seek money from ordinary investors without first spending a massive amount of time and money to hire lawyers and accountants to register the offering with the SEC and relevant state agencies. The cost of registration typically swamps the small sums being sought, so it is not a viable option for most small businesses.

Yet that is the realm that Jackley and Mauriello bravely entered with ProFounder (this kind of fundraising is often called Crowdfund Investing to differentiate it from donation-style crowdfunding). Their vision was to help entrepreneurs reach out to their social networks—friends, family, neighbors, fellow students or loyal customers—to raise money in return for a small share of the revenue.

They called their brand of crowdfunding "community-funding," since it is a much more intimate form of investing than tapping an anonymous crowd. Although regulators are rightly concerned about protecting small investors, this kind of community-funding is much less vulnerable to the charlatans that troll the Internet, precisely because of the social bonds and accountability that exist in these networks.

Like many crowdfunding advocates, Jackley and Mauriello were hoping that legislation working its way through Congress that would make it legal for ordinary Americans to invest in small, private businesses would pass, opening up new opportunities. Yet, despite strong bipartisan support, the legislation is currently hung up in the Senate and is facing strong resistance from state regulators.

(To learn more about these bills and voice your support for crowdfunding, see legalizecrowdfunding.org and WeFunder)

The result is that innovation in a vital area—the intersection of social media and finance—that could create jobs and rebuild local economies and Main Streets is being stifled.

While we dither, Crowdfund Investing is taking off in other areas. In England, for example, securities laws are more accommodating and crowdfunding sites have been operating for more than two years now with no fraud, scams or wiped-out investors. Funding Circle, a two-year old London-based website, has rased more than £25 million in loans for British small businesses, earning investors average gross yields of 8%. Crowdcube, an equity-based crowdfunding site also based in London, just marked its one-year anniversary with £2.7 million raised in equity for 11 companies, including Kammerling's, the maker of a ginseng-based artisanal spirit, and The Rushmore Group, which owns three clubs in London. It even crowdfunded itself to the tune of £300,000.

And herein may lie the ultimate irony. As Americans, we pride ourselves on being innovators, the home of companies like Apple, Google and Facebook that are admired around the world. Yet when a Facebook for Finance emerges, it is not likely to be in California or New York or any other U.S. city. As one British crowdfunding entrepreneur told me: "It used to be that you came up with a good idea over here and the first thing you did was hop on a plane to the U.S. to get it funded." In fact, when developing Seedrs.com, a soon-to-be launched equity crowdfunding site, he considered the U.S. but concluded that securities laws made it impossible to operate there. Now London and other European cities, he says, are becoming new centers of innovation.

I hope our leaders are listening.