Waiting to sow the seed fundingDecember 28, 2012: 5:00 AM ET
The JOBS act was supposed to kick start crowdfunding. Now it's stuck waiting for the SEC to determine how the masses can invest in startups.
By Kurt Wagner, reporter
FORTUNE -- Crowdfunding, a relative newcomer to the investment industry, is stuck in legislative limbo. President Obama signed the JOBS Act in April, but the business world is waiting for the Securities and Exchange Commission to issue rules for the law. The JOBS Act will make it easier for startups and entrepreneurs to access capital, with crowdfunding serving as the investment platform. But the details surrounding just how this new investment arm will operate have been left up to the SEC. The rules, whenever they are unveiled, will have a dramatic impact on the way that startups are funded.
The idea behind crowdfunding is that entrepreneurs or inventors can raise money for an idea by pooling together funds donated by the general public. Fundraisers create an online campaign highlighting their idea and use a crowdfunding platform like Kickstarter or Indiegogo to promote it. Interested donors can then contribute money to a campaign, often times in exchange for perks or small gifts. The industry raised $2.8 billion in 2012, according to a report by research firm Massolution. Many of the campaigns feature charitable causes or niche consumer products, but more mainstream businesses like grocery stores and clothing retailers have grown from this source of public funding, too.
Under current legislation, entrepreneurs can only solicit equity-based investments from accredited investors, or entities deemed by the government to have enough wealth to invest in startups. The result is that many startups are self-funded or rely on bank loans to get started, because they can't offer a stake in the company to just anybody. Under the JOBS Act, young businesses can use crowdfunding to raise up to $1 million annually from non-accredited investors, or the general public. The law makes it possible for nearly every adult in the country to invest in private businesses, versus less than 4 million accredited investors eligible today.
The JOBS Act will provide more access to capital for entrepreneurs, and greater investment opportunities to financiers. But the SEC has yet to issue rules on the new law, and President Obama has set a deadline for January. Some in the crowdfunding industry think this deadline will not be met. Slava Rubin, co-founder of Indiegogo, says the pieces are in place for an equity-based crowdfunding system to take root in 2013, but isn't optimistic that the process will happen quickly. "I'm not holding my breath," he says. If the SEC does issue rules on the law, don't expect an announcement before late spring or even summer of 2013.
Proponents of the JOBS Act are confident that the law will boost job creation. "Entrepreneurs are what drive our economy," says Eric Corl, co-founder of Fundable, a crowdfunding platform launched this year specifically focused on startup campaigns. "(The JOBS Act) fuels more innovation, more creation and increases the momentum at which a company can grow and hire more workers."
Over the past 15 years, 64% of new jobs have come from small businesses. The creation of technology jobs, in particular, has an even greater effect on the community. A recent report by the Bay Area Council Economic Institute found each new tech job creates 4.3 indirect jobs in the same community. And with more startups materializing, venture capitalists will have a stronger, more versatile pool of companies to finance. "I think (the JOBS Act) is net positive," says Chi-Hua Chien, a partner at VC firm Kleiner Perkins. "We don't have a constraint in capital. We have a constraint in the number of high quality opportunities that we are able to invest in. There's just not that many."
But these benefits remain more of a theory than a reality as the January deadline looms closer. Crowdfunding sites still don't know how the system will work – will they need to register as a broker/dealer with the SEC? What about funding portals (which don't officially exist yet)? The SEC's rules will determine how challenging this new equity-driven offering will be for crowdfunding platforms. There is little doubt that roadblocks will be met along the way, including the possibility of fraudulent campaigns. Corl and Rubin agree that some people will lose money, but they don't see fraud as the issue. "It's not like equity crowd funding, whenever it comes out, will be all roses and rainbows," says Rubin. "I'm sure there's going to be a lot of people who don't make money because, as a default, investing in new companies is often net negative. Most companies fail."
Congress is betting that at least some of those companies succeed. And after a success story or two, the budding crowdfunding industry could get a lot more, well, crowded. "I think there is room for a number of crowdfunding platforms to carve out successful niches," says Doug Rand, a senior policy advisor within the White House Office of Science and Technology Policy.
With a new industry awaiting the details of an unprecedented law, 2013 is shaping up to be a watershed year for crowdfunding businesses.