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President Obama’s job package, one measure seems to have rare bipartisan support: a proposal to loosen some of the outdated securities regulations that hamper small businesses in raising capital.

Pennies From Many


September 25, 2011

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President Obama’s job package, one measure seems to have rare bipartisan support: a proposal to loosen some of the outdated securities regulations that hamper small businesses in raising capital.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

Crowdfunding has the sort of populist, common-sense appeal that resonates with free-market libertarians and champions of the working class. By marrying online social networks with finance, this model 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.

It’s 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. The popular appeal of crowdfunding can be seen in the success of sites like Kiva, a microlender, and Kickstarter, which lets people donate money to artistic ventures. In its first six years, Kiva has arranged nearly $250 million in loans from more than 600,000 individuals to microentrepreneurs around the globe. Kickstarter users are pledging funds at a rate of $2 million a week.

But let’s be clear: this is philanthropy. In the case of Kiva, lenders get their money back (assuming there is no default), but earn no interest. And beyond a few tokens of appreciation, Kickstarter members get only the satisfaction of seeing an undertaking they support come to life. That’s because if either site were to allow members to earn a return on their money, they would be subject to federal and state laws governing the sale of securities.

Under those laws, crafted largely in the 1930s, the sites would have to either limit the fund-raising to wealthy investors, who the S.E.C. deems sophisticated, or go through a registration process that would prove too costly given the small sums being sought.

For a glimpse of what is possible, look at Britain, where securities laws are helpful to crowdfunding and several start-ups are vying to be the Facebook of finance. The year-old Funding Circle, a business-lending site based in London, raises more than $2.3 million each month for small businesses from individuals who can invest as little as $30 and earn an average yield of roughly 7.3 percent after fees. Those are loans; two other start-ups are applying the model to equity shares in small companies.

In the United States, these outdated laws are cutting off a huge pool of potential capital for small, private businesses that have been all but abandoned by banks and Wall Street. The proposed crowdfunding changes would make it easier for entrepreneurs to tap ordinary investors — often customers or people in their social networks — for funds, with the promise of a return.

The Securities and Exchange Commission has been considering proposals to ease restrictions on crowdfunding. One petition, prepared in 2010 by the Sustainable Economies Law Center and, fittingly, paid for by a grass-roots crowdfunding effort, asks the S.E.C. to permit entrepreneurs to raise up to $100 per individual and an aggregate of up to $100,000 without requiring expensive registration and disclosure.

President Obama, as part of his jobs act, advocates an exemption for sums totaling up to $1 million. Representative Patrick McHenry, a Republican from North Carolina, has drafted legislation that would allow companies to obtain up to $5 million from individuals through crowdfunded ventures, with a cap of $10,000 per investor, or 10 percent of their annual incomes, whichever is smaller.

There are real concerns. The S.E.C. must balance its dual mission of facilitating investment and protecting investors, and as we all know, snake-oil salesmen are alive and well on the Internet. Furthermore, Wall Street banks are likely to fight any efforts to encourage crowdfunding because it cuts them out of the equation. But the potential rewards outweigh the risks. With such sums, the hazard to any single investor is limited. And information is more freely available today than in the 1930s, when the regulations were written.

Besides, isn’t this the type of innovation we should be encouraging? Unlike exotic derivatives and super-fast trading algorithms, crowdfunding generates capital for job-creating small businesses. As Congress debates the merits of the president’s jobs plan, a crowdfunding exemption should be given a serious hearing — and the slow-moving S.E.C. a serious prod.

Amy Cortese is the author of “Locavesting: The Revolution in Local Investing and How to Profit From It.”

Read this op-ed at the New York Times website here.

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