The lending markets still aren’t proving to be a reliable source of funding for small businesses and business startups and because of the size or lack of a formal structure, the capital or investment markets have been virtually off limits to businesses looking for startup funds.
If president Obama has his way, that will change. In the newly announced jobs bill, Obama is pushing for Congress and the SEC to loosen restrictions that would allow for an increased level of crowdfunding.
Under current rules, a company cannot have more than 500 investors without being subject to the same financial reporting rules as publically traded companies. Of course most small businesses are lucky to get five sources of funding let alone 500 but if this rule is changed, it opens the door to further expansion of crowdfunding.
Here’s how it works. Somebody with an innovative idea, cause, or other need for money can post their idea on a crowdfunding internet site and attempt to create a buzz that attracts money. In some arrangements the money contributed is an investment in the company. Other times, such as raising money for a disaster relief effort, the money is a gift to the company providing the aid.
From the standpoint of a small business owner, there are pros and cons to a crowdfunding arrangement. First, when multiple sources of small funding come in, no one person has a substantial stake in the company which allows you to retain operational control. Second, the money is often borrowed at favorable rates or even better, given with no expectation of being paid back.
Any business startup owner has to be careful with crowdfunding under current law. Any time a solicitation to investors meets the criteria of an investment opportunity it falls in to a complicated series of SEC regulations. These regulations are too complicated for an inexperienced business owner to understand and will most likely require an attorney. Even if you go through a crowdfunding website, move cautiously.
If President Obama gets his way and the laws are changed, it still may require legal assistance to comply with the new regulations. The SEC is unlikely to remove all of the complicated regulations since it would invite fraud by some.
Last, there could be questions of who owns the intellectual property and other aspects of the company. Remember that any time you take money from investors, you’re giving up something for that money.
Even with the potential downsides, crowdfunding could be the perfect option for companies who need startup funds but can’t get them from the bank or venture capital.