Crowdfunding Is About to Get Legit: Here's What You Need to Know

Posted by Dave Burdick

I'll probably never invest a meaningful amount of money in a startup or donate enough money to a museum to name a wing after me—or even a bathroom—but I've taken real pleasure in spending my hard-earned dough on a couple of Kickstarter projects. Looking at my backer history on the site, I see that I've only backed projects by people I know.

That's partially due to my lingering questions about crowdfunding: Where's the money actually going? How long until the I see results? How do I know you're not a lying liar? Basically the same questions I ask when I order fast food or make other significant investments.

But crowdfunding as we know it is about to change dramatically. Right now, when you back something on Kickstarter, you're technically a donor. Soon, you'll be able to actually invest in businesses, thanks to a change in legislation made by the JOBS Act.

This has the North American Securities Administrators Association (NASAA, oddly) very concerned. We got in touch with NASAA Director of Communications Bob Webster to learn why. The conversation below has been edited for length and clarity.

GOOD: Can you briefly describe what is about to happen to crowdfunding?

BOB WEBSTER: Through the JOBS Act, the crowdfunding concept is going to expand from allowing individuals to make donations to a cause or a project to allowing any company, no matter how small or speculative, to use the internet to raise up to $1 million each year by selling investments in the company to thousands of investors. 

GOOD: Right now, if I put $100 of my money toward a band's new album on Kickstarter, am I considered an investor? Is anybody protecting my money?

WEBSTER: No, you are a "donor," not an "investor." Currently, there are no regulatory safeguards for your donated money.

GOOD: After the SEC finishes writing its rules, what kinds of things will I be able to crowdfund that I can't right now?

WEBSTER: Under the JOBS Act, you would be able to invest in small businesses and entrepreneurial ventures with the expectation of a financial return on your investment.

GOOD: What is NASAA's fear relating to crowdfunding?

WEBSTER: NASAA appreciates that the concept of crowdfunding is appealing in many respects because it provides small, innovative enterprises access to capital that might not otherwise be available. But we also know that con artists follow the headlines. Because the potential for fraud is significant, NASAA has urged investors to be extremely cautious about crowdfunding investments.

The Jobs Act eliminates from the mix the state securities regulators who have the most direct interest in seeing small, local businesses thrive. Instead, the JOBS Act puts the sole regulatory oversight of crowd-funding offerings in the Securities & Exchange Commission's hands, but gives the SEC no additional funding to deal with the deluge of new offerings. 

GOOD: Plenty of people don't share your organization's concerns. What do you make of criticism from this VentureBeat post by Jason Best and Sherwood Neiss arguing that safeguards already exist and that they're supplemented by the intelligence of the social web?

WEBSTER: Our position on equity crowdfunding is based on experience and recent history. Congress created a similar investor trap in 1996 with the passage of the National Securities Markets Improvement Act (NSMIA), which prohibited states from reviewing private offerings made under SEC Regulation D Rule 506 before they were sold to the public. Since NSMIA, the provisions of Rule 506 and other limited or private offering provisions have been used—and continue to be used—by unscrupulous promoters to fleece investors. In fact, state enforcement records show these private offerings to be the most frequent source of enforcement cases handled by state securities regulators. 

GOOD: What steps can consumers—and in the future, investors—take to make smart decisions when considering crowdfunding, both in its current state and once the JOBS Act rules kick in?

WEBSTER: In May, NASAA issued an investor alert on crowdfunding and offered a series of things investors should consider before investing in a crowdfunded offering. 

Photo via (cc) Flickr user Anirudh Koul