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SEC Holds Debt/Equity Crowdfunding Hostage

Words by Andrea Newell

TriplePundit Sponsored Series

The Rise Of The Sharing Economy

As crowdfunding on sites like Indiegogo and Kickstarter experienced a huge surge in popularity in 2011 ($1.5 billion raised) and 2012 (estimated $3 billion), it was easy to forget that one of the key elements of the industry has been held up by the SEC for nearly a year, with no resolution in sight.

When President Obama signed the JOBS Act into law in April 2012 (the U.S. House of Representatives passed it on March 8), it was with the intent to break down the barriers for regular people to be able to invest in small businesses. However, absent a concrete set of rules by the SEC, they still can't.

Another name for crowdfunding in its current form: Philanthropy

But, how then are these campaigns raising so much capital and what about the success stories like Pebble and Stick N Find? The key word here is "invest." People who contribute money to a campaign on Indiegogo or Kickstarter are not assuming the role of an investor where they will become a stockholder, but they might receive a gift or a product in return for giving money.

"Giving" is another operative word, as the contributors to the Hanfree campaign discovered after they never received the product they were promised when the campaign reached its goal. The company was unable to fulfill orders and eventually went out of business, leaving supporters empty handed. As fellow 3p contributor, Jan Lee, reported, a Kickstarter contributor sued Seth Quest and taught everyone in this nascent industry a lesson: any funds given to a campaign on a Kickstarter or Indiegogo platform should be thought of as a donation. Any type of gift you might (emphasis on "might") receive as a result is just gravy.

Did this revelation throw cold water on crowdfunding? Not at all. Indiegogo and Kickstarter and other sites are still going strong and estimates for funds raised in 2013 are as high as $500 billion.

Crowdfunding for investors is still illegal

When President Obama signed the JOBS Act, he "essentially created a new industry," said Candace Klein of SoMoLend. It was then up to the SEC to define the rules for investors in this new financial landscape. After missing several deadlines, nearly a year later it's anyone's guess as to when they will finalize and publish their guidelines, but Klein believes it will be in the fall of 2013 or the first quarter of 2014.

There are four types of crowdfunding: donation, reward, debt and equity. While Indiegogo and Kickstarter can operate legally by offering donation and reward crowdfunding, inaction by the SEC has paralyzed debt and equity crowdfunding, where every day people can make meaningful investments in small businesses and possibly see a return on their money.

SoMoLend is one of many debt/equity crowdfunding companies that formed in anticipation of the opportunities created by the JOBS Act. These ventures raised money (the pre-JOBS Act way) and geared up for a landslide, but have instead been sitting on the sidelines. SoMoLend, Klein explained, struck a partnership with Gate Technologies that allowed them to facilitate funding deals, but they are not allowed to profit in any way from these transactions. If the SEC does not take action soon, SoMoLend and companies like it could go under and the debt/equity side of crowdfunding could be dealt a crushing blow that would set the entire industry, and all it's trying to accomplish, back.

SEC has changed leadership three times in the past year. Previous SEC head, Mary Shapiro, was a vocal opponent of crowdfunding. She stepped down in November 2012, when Elisse Walter took the helm. Klein believed Walter's appointment was a hopeful sign. Walter seemed receptive to discussion about crowdfunding and Klein was optimistic that the rules would come online soon. Then, abruptly, the announcement came that Walter would be replaced by Mary Jo White in early 2013. White's feelings about crowdfunding are unknown, and Klein fears this will delay things further.

Why we need crowdfunding

Why is crowdfunding so important?

"Investment through traditional channels has become nearly impossible," Klein said, "and the Dodd-Frank Act just created more regulations." These restrictions put a stranglehold on capital, Klein added, and banks see no upside to investing in small businesses, so they rarely do. With the economic downturn, things have been dire for small businesses since 2008. Without funding, it is impossible to innovate and move forward. Crowdfunding and the JOBS Act open up new avenues of financing for entrepreneurs to explore, and they extend investment opportunities to everyone, not just the wealthy.

With the rise of the sharing economy and the turning tide toward collaboration, this is the perfect time for crowdfunding to take off. Kate Drane, Director of Vertical Market Development, Design and Technology at Indiegogo, said,

"The sharing economy, at its core, is people sharing resources to help one another get something done or achieve something they couldn't have without this relationship. Crowdfunding allows people to fund their dreams based on contributions made by their friends, neighbors, and strangers that rally behind their idea, project or product. It demonstrates that people are willing to make a contribution understanding that there is no guarantee of a return, and that's pretty powerful."

Just imagine the impact if the other half of crowdfunding was defined and allowed to flourish. Klein acknowledges that once the SEC defines the parameters for crowdfunding, it could place some additional restraints on the industry, but overall it would  open a floodgate of business opportunities. "The JOBS Act is the most important legislation passed in our lifetime," Klein said.

Want to crowdfund your project?

Despite the SEC holdup, Klein believes that entrepreneurs with a good idea shouldn't wait to take advantage of crowdfunding. Indiegogo and Kickstarter (and similar platforms) are great places to learn about the ins and outs of the industry. Businesses can test their idea, practice marketing their product or project, learn about transparency and get their supply chain in place in anticipation of their project being funded and making good on any promises to donors. Drane agrees, adding that Indiegogo offers a host of support services designed to help users create successful campaigns. Once the SEC rules are published, forward-thinking entrepreneurs will be perfectly placed to move into the debt/equity crowdfunding space.

Ultimately, there needs to be more communication with the SEC, encouraging them to finalize and release the rules. "Every day we don't have crowdfunding in the U.S. is a missed opportunity for our country and small businesses." Klein said.

[image credit: Nathan Rupert: Flickr cc]