Move Over JOBS Act: States Are the Real Laboratories for Crowdfunding

Today marks two years since the passage of the JOBS Act—the landmark legislation that was supposed to open up gushers of capital for the nation's small businesses and create jobs. But as the law inches closer to implementation, it's becoming clear to even (or especially) the law's most ardent supporters that it will fall short of those lofty goals. If the SEC's 600 pages of proposed crowdfunding rules are adopted as laid out, the complexities and requirements they entail will likely make it too expensive and onerous for most of the small businesses the law was originally intended to help. 

For example, the SEC estimates that companies raising less than $100,000 could pay up to 15% in legal and other fees. For companies raising $1 million (which requires audited financials), the costs could be as much as $250,000.

As that reality sets in, a number of states impatient to spur job creation and entrepreneurship are crafting laws that allow investment crowdfunding within their own borders. Kansas was the first, with its Invest Kansas Exemption (IKE), followed by Georgia. In late 2013, Wisconsin and Michigan joined in with laws of their own. 

Already this year, Maine, Alabama, Washington, Indiana and Maryland have passed their own mini-JOBS Acts, and many more are likely to follow. Why? Because they see it as pragmatic economic development, a way to strengthen their local economies. 

“I hope that IKE can serve as a model for all fifty states,” one Kansas state regulator told me. (Fittingly, Kansas was the first state in the country to regulate securities, in 1911. The argument—to keep "Kansas money in Kansas" and help local farmers and businesses rather than enriching "New York Stock Exchange speculators and gamblers"—rings as true now as it did then. (See chapter 2 of my book for more on these genesis of the Blue Sky laws) 

Although the state laws vary, generally they allow any business based in the state to raise money from any resident of the state, without all of the red tape and restrictions entailed that come with JOBS Act crowdfunding. In Kansas and Georgia, for example, companies raising money submit a simple one-page form to state regulators, and there are no audited financials required. Unlike the JOBS Act, transactions in those two states don't even need to take place on a portal (although I think portals can provide clear value). 

Because companies are restricted to raising money from residents of their state, intrastate crowdfunding may not appeal to high-flying firms that can attract a national or global audience of investors. But then, those companies typically do not have problems raising capital—unlike thousands of smaller or less sexy businesses that the JOBS Act was expected to boost.

So where does state crowdfunding stand? It's been slow to take off so far, mainly because it is so new and much education needs to be done. In Kansas and Georgia, there have been just a handful of deals so far, and many residents still don't know the laws exist. I'm most impressed with Michigan, which is taking a more hands on approach to promote the Michigan Invest Local Exemption (MILE). The Michigan Municipal League, a well respected organization that represents counties and towns throughout the state, has taken the lead in educating businesses and investors, and has partnered with two crowdfunding platforms- Localstake and Fundrise - to encourage MILE deals. The first Michigan state crowdfunding campaign - for the Tecumseh Brewery - is now live on Localstake. 

I still hold out hope for a workable JOBS Act someday. But, as with so many things these days, states are becoming the true laboratories for crowdfunding. They have an opportunity to show how crowdfunding—or in this case, communityfunding—can be done. 

Me & Patrick McHenry at the Rose Garden signing ceremony April 5, 2012

Crowdfunding: Don't Start Your Engines Just Yet

Crowdfunding has landed with a thud! On Wednesday, the SEC issued 568 pages of proposed rules for Title III of the JOBS Act – aka crowdfunding. Embedded in it were 295 questions for interested parties and the public at large to comment on, ranging from how to calculate the $1 million per year limit on how much issuers can raise (ie. should that be net of fees? should other non-crowdfunded fundraising be included or exempted?) to the economic impact of the proposed rules (question #295). 

SEC commissioners weighed in on the historic moment, proclaiming it a step forward in a "bold experiment" that has "great potential" to unleash capital for the nation's small businesses, but one that will take some time to get right. Others interpreted the voluminous proposal as the SEC kicking the can further down the road while appearing to fulfill its duty to issue rules mandated in the JOBS Act (already more than ten months behind). 

While the details are sorted out, the broad outlines of crowdfunding remain the same: 

- Companies can raise a maximum of $1 million through crowdfunding in a 12-month period
- Investors whose income and net worth are less than $100,000 are limited to $2,000 or 5% of their income, whichever is greater, in aggregate crowdfunding investments over a 12-month period
- Investors whose annual income or net worth is greater than $100,000 may invest up to 10% of their income or net worth, not to exceed $100,000 in a 12-month period
- All crowdfunding transactions must take place on an SEC-registered intermediary - either a broker-dealer or a crowdfunding portal
- These intermediaries must take measures to educate investors and mitigate fraud
- Companies raising money on these platforms must provide basic financial information (the proposed rules require audited financials for offerings greater than $500,000)

So when can we expect mainstream investment crowdfunding to be ready for prime time? 

Not so fast. 

Wednesday's proposed rules kick off a 90-day comment period. At the end of the comment period, SEC staffers will study the comments and consider whether to recommend tweaks to the proposed rules to their bosses. Sara Hanks, an attorney and the CEO of CrowdCheck, notes that the end of the comment period does not imply any action on the part of the SEC – in fact, in practice, proposed rules often languish for many months. Given the controversy surrounding crowdfunding and the magnitude of the questions buried in the proposed Title III rules, this recommendation stage is likely to stretch on for at least three months, if not many more.

The next step would be for the SEC commissioners to formally adopt the rules (or reissue rules and start the process all over again, which is considered unlikely). Bottom line: final crowdfunding rules are not likely to be released until six months out, at the earliest. 

Add in some time for FINRA, the industry regulatory body, which must issue its own rules and guidance, and a registration period for crowdfunding portals, and mainstream crowdfunding will not be a reality until mid-2014 at best.

In the meantime, read the proposed rules here, and offer your own (constructive) comments here.

When Buying Local Doesn't Build Community Wealth

Buy local. Support local business. These are the rallying cries that community-boosters (including

myself) use all the time. When you spend money at a local business, the theory goes, more of that money circulates in the community, supporting other local businesses as well as charities and boosting the local tax base.

Except when it doesn't.

Maggie Anderson, the author of Our Black Year, opened my eyes to the fact that, in many neighborhoods—especially poorer Black ones—the 'local' businesses are not owned by people who live there, so the money spent at them flows right out of the community. African Americans account for 14% of the population, but they make up only 5% of business ownership in this country (and most of those businesses are sole proprietorships). The reasons are complex, but the reality is that, while African American buying power has surged, little of that spending is actually helping build wealth in Black communities. 

Anderson cites some startling statistics:

A dollar spent locally circulates nearly a month in an Asian American community before the money flows out.

In Jewish communities, it sticks around for about 20 days. 

White Anglo-Saxon Protestant neighborhoods enjoy a locally spent dollar for roughly 17 days. 

African American communities? Six hours. 

  

All neighborhoods have "leakage" — money that flows out of the community and into the hands of nonlocal business owners, chain stores, bankers, landlords, etc. But it's particularly acute in some Black neighborhoods. For every $100 spent in an "underserved Black community," about $95 leaves, says Anderson, citing a 2004 report. 

To call attention to the lack of Black-owned enterprises, she and her family spent a year trying to buy only from Black-owned businesses around their Chicago neighborhood. The results of this Empowerment Experiment, as they call it, are chronicled in her book. I won't be spoiling anything to say that it wasn't exactly a rousing success.  

Anderson's book is a reminder that not all neighborhoods are created equal, and that the 'local' movement must become more diverse (to its credit, the Business Alliance for Local Living Economies featured Anderson as a keynote speaker at its 2012 conference, where I found out about her project and book). 

So when I heard about the Kingonomics conference taking place this week in Washington, DC, I was intrigued. Timed to commemorate the 50th anniversary of the March on Washington, where Martin Luther King gave his enduring "I Have a Dream" speech, it brings together entrepreneurs, innovators, civil rights leaders, businesses and investors inspired by the economic philosophies of Dr. King. Yes, economic philosophies. As Kingonomics author and conference organizer Rodney Sampson explains, many people don't realize that Dr. King was very focused on economic issues, believing that without economic opportunity, people do not have the chance to pursue happiness. Before his death, King campaigned for an "economic bill of rights" and called upon the government to invest in rebuilding American cities.

"The modern day civil rights movement has evolved into an economic rights movement for all to participate," writes Sampson. To that end, the conference entails two days of entrepreneur bootcamps, capital raising education, crowdfunding and pitch competitions for entrepreneurs, capped by an "Emancipation of Capital" gala. 

This is where I get excited about the potential for crowdfunding to help minorities, women and other entrepreneurs too often cut off from traditional funding sources. At its best, crowdfunding is about democratizing access to capital, so that ideas get funded based on their merits, not on powerful connections or where you went to school. So here's to MLK's dream, and the dreams of entrepreneurs everywhere, to make a difference in the world. We just have to give them a chance. 

The Real Risk With Crowdfunding

When the JOBS Act was signed into law last April, entrepreneurs were elated, even giddy, at the prospects. They and other supporters saw it as a democratizing force that could unlock new sources of capital for job-creating entrepreneurs, boost the economy and give Wall Street-wary investors a profitable alternative. It was one of those disruptive innovations that comes along once a generation and radically transforms the competitive landscape. It was so potentially revolutionary that pundits and financial pros alike predicted it would put many venture capitalists and banks out of business—in other words, exactly the sort of game-changing opportunity that makes entrepreneurs dream big.  

Well, ten months later, the enthusiasm has cooled. Not for the potential of crowdfunding, but for the realistic chances that it will be enacted anytime soon and in a form that honors the original intent of legislators to ease the bottlenecks that prevent so many entrepreneurs and small business owners from obtaining the capital they need to grow, hire and thrive. The SEC, which was charged with writing the rules that will govern the nascent crowdfunding industry by year-end, has missed that deadline (not surprisingly–the agency is concerned about the potential for fraud and has a lot on its plate already). Most people now believe true investment crowdfunding will not get underway until 2014. At the same time, it appears likely that the rules will require the new crowdfunding portals to be regulated much like conventional broker-dealers—in other words, more Merrill Lynch than eBay, as one observer put it. For better or for worse, crowdfunding may turn out to be a game not for idealistic entrepreneurs but for well-capitalized investment pros. 

As I wrote in my recent feature for the New York Times, despite the uncertainty, the outlines of a new industry are beginning to take shape, and with it a glimpse of what a crowdfunding future might look like: promising young companies able to get funding from people who  believe in them, regardless of those investors' net worth; new jobs being created by the availability of growth capital; and more broadly shared prosperity and economic opportunity. Sure, there is a risk of fraud and loss with crowdfunding. But then, that takes place every day on Wall Street. As Thom Ruhe, vice president for entrepreneurship at the Kauffman Foundation, told me, with the economy stuck in limbo, the bigger risk to the economy is to do nothing at all. 

Kickstarting the Indie Food Scene

I've been a bad blogger, I know. I will not even tally up how many weeks have passed since my last post! So thank you for hanging in there. I intend to revive this blog - and indeed build it into something much bigger - in the coming months. In the meantime, let me ease back in by sharing a story I recently wrote for Edible Manhattan about Kickstarter and its role in funding a new crop of indie food entrepreneurs:

THE EDIBLE ECONOMY: RAISING DOUGH
First published in the November-December 2012 edition of Edible Manhattan

When Dan Maniaci and Piergiorgio Maselli were Boston College students with an appetite for more than knowledge, burgers were a shared obsession. Sliders, Big Macs, Shackburgers, animal-style In-N-Outs—they devoured them all (Maniaci earned the nickname “Tapeworms” after scarfing 11 cheeseburgers in one sitting).

Still, for all the great burgers they could order while out, the two undergrads lamented the pathetic state of patties made at home: overcooked and drowned in ketchup. So they began making their own burger sauce in an effort to resuscitate the home burger experience.

From their tiny dorm kitchen, the pair experimented with recipes and tried them out at tailgate parties until they hit on their Top Secret Burger Sauce— Maselli likens it to “a zesty mayonnaise with some spice.” After graduating in 2010, they moved to New York (“burger nirvana,” says Maniaci) with big plans to launch Gotham Sauce Co.

But, like many would-be food entrepreneurs with little credit history and no collateral, they found the up-front costs—renting a commercial kitchen space, contracting with a manufacturer, securing the right permits—were out of reach. “We didn’t even bother going to a bank,” says Maselli.

In years past, their story would have ended there. Instead, this September, Maniaci and Maselli turned to Kickstarter, a three-year-old company on the Lower East Side whose Web site lets ambitious but underfunded entrepreneurs appeal directly to friends, fans and future customers who believe in their idea. They put together a video pitch explaining their quest “to give the homemade burger a better life” through their secret sauce. And they promised perks to anyone who made a donation—from “a warm and fuzzy feeling” for a $1 contribution, to a bottle of Top Secret Burger Sauce for a $10 pledge, all the way up to a gourmet tailgate party cooked by the two 24-year-old entrepreneurs for a $2,500 pledge.

On September 15, just four days into a monthlong funding campaign, they hit their $5,000 goal—modest seed money that would allow them to start commercial production and shop the product around. But contributions continued to pour in, from friends, family, classmates and random burger lovers. With more than a week to go, 950 people had chipped in a whopping $18,500.

Maselli, a New York native now in law school at St. John’s, called the tremendous response “a vindication” of the venture. He and Maniaci are finalizing arrangements with a co-packer and plan to ship their first products in December. Armed with bottles, they can also begin calling on specialty stores and supermarkets, he adds.

Welcome to the Kickstarter economy.

Read more here or go to http://www.ediblemanhattan.com/featured-article/raising-dough/ 

In Defense of Crowdfunding

Crowdfunding legislation is tantalizingly close to becoming reality—the Senate is expected to pass a version of a bipartisan House bill within days. But a rash of negative publicity threatens to derail this important update to antiquated securities laws that hamper small business capital raising.


The problems stem from the Jump-Start Our Business Start-Ups act—JOBS, for short—a House package that rolled together a number of largely uncontroversial bills aimed at spurring small business capital raising, and added some new ones. JOBS has provoked a fierce outcry from consumer protection groups, regulators and pundits, who evoke alarming images of coke-snorting boiler room operators, Nigerian scammers and pump-and-dump research analysts. It seems this bill will make "Muppets" of all of us.


Let's all take a deep breathe and consider this.


The elements of JOBS sparking the most backlash are provisions that loosen regulations on public and pre-IPO companies, including exempting publicly traded "emerging growth companies" from certain reporting requirements, and letting issuers and financial firms peddle securities to accredited (aka wealthy) investors. Fair criticism. I don't see anyone taking issue with other elements of the bill, like raising the ceiling for Reg A offerings and increasing the number of shareholders (from 500 to 1,000) a private company can have before it is considered public.


The other key element of the package is a crowdfunding bill that had previously passed the House with near unanimous support. Crowdfunding has its share of detractors, for sure. But much of the recent criticism seems to be unfairly tarring crowdfunding and other good elements of JOBS with the same broad brush. In the Times, Floyd Norris declared crowdfunding "a major victory for Wall Street." 


That couldn't be farther from the truth.


Crowdfunding, as most people by now know, is a fundraising model where lots of small sums are aggregated from lots of people. Think Kickstarter.com, Kiva.org, and President Obama's initial presidential campaign. Crowdfunding legislation would move that model into the investment sphere, so  entrepreneurs could tap into their social networks to raise capital, and allow those investors to share in the profits. It's Kickstarter with a financial return. 


Under existing rules—rules that were crafted in the 1930s, in the age of ticker tape and telegraphs—that is illegal. Private companies may only raise money from accredited investors. If they want to reach out to their customers, their friends and family, their neighbors or social networks—a perfectly natural impulse—they must hire lawyers and accountants to guide them through a registration process and produce a bulky prospectus that hardly anyone reads. This process can easily cost $1 million or more—making it a non-starter for small firms that only need $10,000 or $100,000 or even a million.


These small firms are shut off from a huge pool of potential capital, at a time when bank lending and seed funding is down dramatically. And ordinary Americans are unable to invest in companies that they know and love and support.


Having spent the past two years talking to small businesses and investors, I can tell you that people want to invest this way. They would like to put their money in companies that they know, that are part of their community, or doing things they believe in. Just look at the success of Kickstarter, which has raised tens of millions of dollars in contributions for creative ventures. The site logged $1.6 million in pledges in a single day this week.


Before it shut down last month under pressure from regulators, ProFounder.com—a crowdfunding platform cofounded by a founder of Kiva—helped dozens of small businesses raise money from friends and family. This kind of capital is supportive, nurturing capital. It's the antithesis of vulture capital or "ripping the eyeballs out" of Muppets.   


In fact, crowdfunding presents a badly needed alternative to Wall Street-style investing. Just as Kickstarter allows independent artists to bypass the traditional gatekeepers like record studios and publishers to get their works produced, crowdfunding can help entrepreneurs with good ideas or promising growth potential get funding that is not forthcoming from banks or VCs. Millions of Americans have moved their money out of big banks to credit unions and community banks; many may want to do the same with some of their investment dollars.  


Yes, there is risk. Investors could lose money or be victims of fraud—just as they can in the stock market. Most of the proposed crowdfunding bills limit the amount that individuals can invest in a crowdfunded venture—the highest allowable amount among the bills is (the lesser of) $10,000 or 10% of their annual income—so the amount any one investor could lose would be limited. (In comparison, there is no limit to what they can lose in the stock market or at the casino, for that matter). The amount a company can raise is also limited, to $1 million (or $2 million with additional disclosure).


It is the risk of fraud that has most critics' knickers in a knot. Without a doubt, hucksters will ooze out of the ether. But there are commonsense measures included in the crowdfunding bills that can address the risk. For example, the Senate bills require companies to go through a crowdfunding intermediary to raise funds. The intermediaries (the equivalent of a Kickstarter or eBay) must register with the SEC. And they must hold funds in escrow until the money is released to the company raising it. In addition, state regulators can prosecute any offenders if someone manages to pull off a fraud.


The crowdfunding intermediaries will also perform a basic level of vetting of the companies they list on  their sites, such as background checks of principals and the like. And let's not underestimate the power of  hundreds or thousands of people dissecting a business plan and crowd-vetting an idea or a company. The Internet brings a new level of transparency to investing, in ways that the framers of the 1930s securities laws could never have imagined. In fact, crowdfunding has the potential to be more transparent than many other investments we can routinely make. Do you know what's in your emerging market mutual fund, or what the hidden fees are, for example? Do you really know what is going on inside that blue-chip bank whose stock you own? (Here's a hint)


Crowdfunding has been taking place for nearly two years in the UK without a hitch, funding hundreds of local businesses. Luke Lang, a cofounder of Crowdcube.com, which has raised more than £2.5 million in equity capital for more than a dozen companies since it launched a little over a year ago, fully expects some companies to fail; that comes with the territory. But so far there has not been a whiff of fraud. Likewise, on Funding Circle.com, British investors have lent more than £23 million to about 600 local businesses in the less than two years, with nary a Nigerian scammer or boiler room creep. 


The bottom line is, the financial system is broken. Small businesses—which create the majority of jobs, contribute half of private GDP and provide the biggest economic boost for their communities—are going begging for capital. Investor protections are predicated on the public markets, yet those markets are closed to 80% of the companies that need them, according to a report by Grant Thornton (pdf here). Small firms are simply priced out. The median IPO size has risen from $10 million 20 years ago to roughly $140 million today. 


We need alternatives. Done sensibly, with the right precautions built in, crowdfunding could unleash a new wave of innovation and job growth. The potential rewards vastly outweigh the risks. I hope Congress and the pundits will separate this issue from some of the more problematic proposals in the JOBS package. 

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.

A "Grande" Idea - Let People Profit From Crowdfunding

Starbucks' recent announcement that it will start taking donations from its tens of millions of customers to help fund small businesses was a grande - no, make that venti-sized - idea. As the NY Times' Joe Nocera explained in his recent op-ed, "We Can All Become Job Creators," Starbucks will act as the middleman, passing along the donations to the Opportunity Finance Network, a group that represents 180 community development financial institutions (CDFIs), which lend to communities underserved by traditional banks. 


With tight credit still holding back many small businesses that might otherwise expand and hire, Starbucks and its CEO Howard Schultz have been rightly praised for this innovative program. It will be interesting to see how many caffeinated customers step up to become small business donors, or "Americans helping Americans," as the wristband they will receive for donations of $5 or more reads.


If the experience of sites like Kiva, Kickstarter and IndieGoGo is any indication, there is a lot of pent up desire among Americans to help out entrepreneurial ventures that they care about. Kiva allows people to make small loans to micro-entrepreneurs around the world and in cities like Detroit, while the other two sites are a conduit for donations to artists and entrepreneurs, such as musicians and filmmakers. Kiva has facilitated nearly $250 million in loans from more than 600,000 individuals, and Kickstarter users are pledging funds at a rate of $2 million a week.


That's impressive. But to really crack the small business capital market open, we need to make it part of the mainstream financial landscape. In other words, let people earn a profit on their money. Donations and no-interest loans are great and have helped a lot of people, but they cannot serve the vast demand for small business capital in this country. That's why I advocated in my own recent NY Times op-ed for changes to our securities regulations that would allow businesses to raise funds from many small investors—a practice known as crowdfunding.


As I wrote in that op-ed:

[Crowdfunding is] the sort of person-to-person (or P2P, in industry jargon) funding that characterized financial transactions for millennia, before our mediated, securitized financial system took hold. Crowdfunding has the sort of populist, common-sense appeal that resonates with free-market libertarians and champions of the working class alike. By marrying online social networks with finance, crowdfunding offers a more democratic model of finance, in which individuals can directly fund other individuals or businesses that they deem worthy, without going through a bank or Wall Street middleman. 

Unfortunately, in this country, it's illegal to raise funds this way in return for a profit. Once a financial return is promised or implied, the offering becomes a security in the eyes of the Securities & Exchange Commission (SEC) and the legal hurdles go way up—putting public capital out of reach for most small businesses.


The laws, put into place after the 1929 stock market crash, were intended to protect investors from unnecessary risk. But the effective result is this: wealthy investors can invest in pretty much anything they like: private equity, hedge funds, venture capital. But ordinary investors (the 99%, you might say) must stick to publicly traded securities.


The problem is, most small business can generally not afford to go public—consider that the median IPO size was $140 million in 2009, up from $10 million twenty years ago! Nor do many want to, given the market volatility and Wall Street's fixation with short term results. (There is also a certain irony to this. In order to protect "unsophisticated" investors, the SEC confines them to the public markets. How safe do you feel about your stock market investments these days?)


So, no surprise, the financial landscape today is dominated by big business investment options. Think about your 401K (if you are fortunate enough to have one of those employer-sponsored plans). These plans offer a menu of funds that invest in the stocks and bonds of large companies (even a "small cap" firm falls between $50 and $300 million—the size of a large cap in the 1980s!). There may be some government bond or emerging market funds thrown in as well. But what you will not find is a small or local business fund. Those things do not exist.


Eight decades after the legal framework of securities law was put into place, the Internet and social networks have transformed the way we do everything, and the regulations look wildly anachronistic. And the vast majority of Americans are prohibited from investing in small and local businesses they want to support, and these firms in turn are cut off from a huge pool of badly needed capital.


That's why there is so much excitement about the growing bipartisan support for a crowdfunding exemption. President Obama has championed crowdfunding through his Startup America initiative, and House Republican Patrick McHenry has drafted a bill that is winding its way through the House. There are also grassroots petitions calling for a crowdfunding exemption before the SEC. The proposals vary in their details, such as the caps on the amount individuals could invest in each deal, but all would allow ordinary investors to put small sums of money in small businesses without requiring the business to go through a long and costly registration process with the SEC.


Yes, small businesses can be risky, but the small sums involved would ensure that no single investor could lose the farm on an investment. And here at Locavesting Central, we believe that community-based crowdfunding—where businesses are reaching out to their customers, neighbors and supporters— would further mitigate the risk. That's because local business owners have a reputation in the community, and potential investors have a greater knowledge of the company and the market it operates in—a key concern of the SEC. (ProFounder, an interesting crowdfunding startup in Los Angeles, is promoting such a "community-funding" model). What's more, I believe that this kind of investing—where individuals have a literal stake in their local businesses and therefore their communities—can help in the renewal of democracy and civic engagement. 


Of course, there is no guarantee that anything will come of these crowdfunding proposals, that's why it is so important to speak up. So sign the petitions (links below), call your elected representatives, and drop a few coins in the donation can at Starbucks.

• The Sustainable Economies Law Center has filed a petition with the SEC that would allow individuals to invest up to $100 in small companies. Details, including how to post a comment with the SEC can be found here. 

• Startup Exemption is another campaign to change the law—add your signature here. 

Pennies From Many

AS Congress considers President Obama’s job package, one measure seems to have rare bipartisan support: a proposal to loosen some of the outdated securities regulations that hamper small businesses in raising capital.


The Obama administration, not surprisingly considering its own success in gathering small donations during his campaign for the presidency, is supporting crowdfunding, a financing model that relies on collecting small sums of money from many people over the Internet.


Read the rest of my op-ed in today's New York Times here. 

Science can be crowdfunded, too

Interesting story today in the Times about scientists turning to crowdfunding to finance their research. Now there's an experiment to watch...