Crowdfunding Promoted to Help Small Businesses

This article was originally published by the Fiscal Times on Sunday, April 17, 2011.

By Katherine Reynolds Lewis

Many small businesses are still struggling to raise capital in the wake of the Great Recession, despite a flurry of government and private initiatives.

President Obama launched Startup America to encourage entrepreneurship, stressing that small businesses traditionally have been the engine of job creation, and Federal Reserve Board Chairman Ben Bernanke regularly talks up his concern for small businesses and keep tabs on small business funding.

Now there's an effort to exempt startup businesses from the complex U.S. securities registration and filing requirements when they acquire relatively small amounts of loans and equity.

The founder of Startupexemption.com, Sherwood Neiss, says the proposal would facilitate the growth of crowd funding by letting small businesses offer returns to small investors with less paperwork and expense. Crowd funders network and pool money and other resources, usually via the Internet, to support businesses or causes initiated by other people or organizations.

The financial crisis and slow economic recovery have exacerbated the perennial difficulty small businesses face in raising startup capital, experts say. Banks and institutional lenders cut back dramatically on loans, not only because of their losses in the crisis, but also because regulators forced them to hold more capital. And even under normal circumstances, angel investors and venture capital firms tend to offer only large investments -- beyond the needs of many small businesses.


"Our economy's fundamental strength lies in startups, entrepreneurism, business formation," said Mark Zandi, chief economist at Moody's Economy.com. "Business formation is at an all time low. ... Increasingly, the problem is the lack of equity capital. Investors are having a hard time figuring out the exit strategies."

Outstanding loans to small business peaked at $336 trillion in 2008, before falling steadily to $291 trillion at the end of last year according to data from the Federal Deposit Insurance Corp. Newly founded private companies created 200,000 fewer jobs in the first half of 2010 compared with 2009 -- a total of 1.7 million according to the Bureau of Labor Statistics.

At an Obama administration Access to Capital conference in March, officials highlighted a commitment of $1.5 billion in government funding with a goal to spur at least $15 billion in additional small business lending. "It's still a tough financing environment out there for small companies, and we want to draw more attention today to the challenges facing start-ups and high-growth companies," Treasury Secretary Timothy Geithner said.

Under Neiss's proposal, the Securities and Exchange Commission would create an exemption for debt or equity offerings smaller than $1 million, in which individuals could commit no more than $10,000 or 10 percent of annual income. Small businesses would use a standardized set of automated procedures, and the "crowd" would vet startup ideas through online channels or sites where fundraising could take place.

"We've got all these small businesses and entrepreneurs out there looking for capital and it doesn’t exist past the financial meltdown," said Neiss, a serial entrepreneur based in Miami Beach. "This exemption will just allow capital to flow more to startups in a transparent fashion with accountability."

The SEC is considering requests to change its rules to make it easier for small businesses to raise capital, SEC Chairman Mary Schapiro said in an April 6 letter to Rep. Darrell Issa, R.-Calif., chairman of the House Committee on Oversight and Government Reform. "The commission will be mindful of its dual responsibilities of facilitating capital formation and protecting investors," Schapiro wrote, noting that the commission recently took a number of steps to encourage small business investment, such as implementing simplified reporting and disclosure requirements for smaller companies.

There is at least one existing crowd funding site that works within the state and federal securities laws. ProFounder has helped 10 entrepreneurs raise $343,000 from 245 investors, according to co-founder and chief executive Jessica Jackley. But securities regulators are concerned that the push to open new funding avenues to legitimate startup companies might also create opportunities for fraudsters and scam artists to solicit new victims.

"There seems to be a big push all around to liberalize the application of the securities laws and the regulation procedures to jumpstart small business. It's extremely dangerous," said A. Heath Abshure, Arkansas securities commissioner and chairman of the corporate finance section of the North American Securities Administrators Association, the state regulators' membership group.

Crowd funding's roots in the arts and humanities may blind supporters to the risk of exploitation, Abshure warned. "Once you open this up and say, 'You can get on the Internet, create a website and advertise all over the country, and people can send you $100,” he said. "The bad guys are going to strip any credibility that marketplace would have, anyway. It's going to be fraud central."