Everyone Is a Venture Capitalist: The New Age of Crowdfunding

Abstract

On April 11, 2012, Eric Migicovsky posted a Kickstarter project to fund production of his idea for a smartwatch--an app-supported that connects to an iPhone or Android smartphone via Bluetooth to provide a range of useful functions, from messaging notifications and music control to distance and pace calculations for runners, swimmers, or bikers. He set his fundraising target at $100,000. A little more than 24 hours later, he had raised $1 million. As of May 3, the project had raised over $8.3 million from nearly 56,000 contributors. The Pebble smartwatch is by far Kickstarter's most successful project in its three-year existence; the average project size is more in the range of $5,000. Migicovsky went to Kickstarter after he failed to get venture capital support for his fledgling company, even with a working prototype, a solid business plan, and some sample apps. But, while who supported Migicovsky's project with pledges of $100 to $10,000 will get a really cool watch, they won't get equity in his company. That sort of exchange is illegal under the Securities and Exchange Act of 1934, which limits the number of a company may have before it must go public--and subject itself to the significant bureaucratic burdens and intensified scrutiny accorded to public companies. A Kickstarter pledge may be an expression of confidence or a preorder, but it cannot be an investment. So, Kickstarter projects don't have investors; they have backers who pledge small amounts in return for personal engagement with a project, and sometimes a token gift. (In Migicovsky's case, the Kickstarter project essentially worked as a preorder mechanism, allowing him to gauge his market as well as gather funding.) The Jumpstart Our Business Startups Act (or JOBS Act) is designed to change that. Signed into law by President Obama on April 5, 2012, the JOBS Act loosens regulatory requirements for small businesses on a number of fronts. It reduces the level and complexity of required SEC filings for businesses below a set income threshold, raises the number of shares a company can issue before it must go public, and offers other regulatory rollbacks. Among them is a provision to legalize crowdfunding--the kind of thing Kickstarter has been facilitating for small projects--as a source of startup financing. Beginning in 2013, entrepreneurs will be able to solicit funding from small and offer equity in return. The term is fairly recent; Michael Sullivan coined it in 2006, and most people have only become familiar with it through the rise of Kickstarter, which was initially focused on creative projects--think indie films or albums. But as a practice, crowdfunding has a much longer history. The construction of the Statue of Liberty was financed in France by a combination of public fees and lottery sales, and the statue's pedestal was paid for by a campaign that solicited small donations from the American people. Trick-or-Treat for UNICEF--a campaign that asked children to collect spare change instead of candy on their Halloween rounds and send the cash to the United Nations Children's Fund--is a form of crowdfunding. But crowdfunding as a venture financing mechanism was made illegal as part of the raft of finance reforms made in the wake of the 1929 stock market crash. In addition to the limits on numbers of investors, current regulations forbid the solicitation of equity investments outside a circle of accredited investors and require extensive disclosures before such investments can be sought. The JOBS Act, originally a small part of Obama's jobs program, attracted bipartisan support by building on the one thing both parties can agree on: small businesses provide most of the new jobs in the U.S. economy, and start-ups are needed to catalyze long-term economic recovery. With conventional financing sources drying up, small businesses are desperate for new ways to get the funding they need. …

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