Critics warn that investment crowdfunding is ripe for fraud
By Marcy Gordon
AP Business Writer
WASHINGTON (AP) — Crowdfunding is about to go big time.
Once just a hip way of raising money to make a movie or help out a good cause, crowdfunding is expanding to a whole new arena. But in the coming year, startups may be allowed to sell stock in their companies over the Internet to a national pool of small-time investors.
For those investors, it’s a chance to make a profit and possibly get in early on the next Twitter or Facebook. But it’s also extremely risky, given that a majority of startups fail. And critics warn that investment crowdfunding is ripe for fraud.
The Securities and Exchange Commission on Wednesday took a step toward implementing a law passed last year that would allow companies to issue stock through crowdfunding. The SEC voted 5-0 to send regulations for the practice out for public comment. Final rules could be approved next year.
Under the proposal, people with annual income and net worth of less than $100,000 could invest a maximum of 5 percent of their yearly income. Those with higher incomes could invest up to 10 percent. Companies could raise a maximum of $1 million a year from individual investors.
Companies also would be required to provide information to prospective investors about their business plan and financial condition, as well as a list of their officers, directors and those who own at least 20 percent of the company.
Crowdfunding is hardly new. Sites like Kickstarter and Indiegogo have for years helped fund projects through donations raised online. Through those sites and others, supporters can pledge $10 — or tens of thousands of dollars — to help start a project, be it a business, a charity or the arts. In return, supports can receive a gift, such as a T-shirt or a song named after them. Or they can simply feel satisfied knowing that they helped a good cause.
But under the law enacted last year, business would be able to offer investors a piece of the company for the first time. Investment crowdfunding could be a pathway to getting in early on the next big trend. Experts warn that the reality is nearly 55 percent of startups fail within five years.
Still, the latest iteration of crowdfunding could help those startups that failed to attract attention from venture capitalists. Supporters say this kind of investment crowdfunding could create jobs and boost economic growth in overlooked areas of the country, such as the Midwest.
New businesses there don’t have access to pools of capital provided by Wall Street or Silicon Valley, says Robert Hoskins, who does public relations and marketing for crowdfunding ventures.
“It’s going to save America’s butt,” he said.
But investor advocates and other critics express concern that this new arena of investing could be a breeding ground for fraud.
At the same time, investing in startups by its nature can be risky. And there’s potential for fraud.
While many companies are started by entrepreneurs with good intentions, “there could be some sharks out there as well,” said William Beatty, the director of securities in Washington state. “I hope a lot of people don’t get hurt,” he said in a telephone interview.
SEC Commissioner Luis Aguilar said unscrupulous operators could use investment crowdfunding to prey on “vulnerable segments of society.” The system could enable “affinity fraud,” he said, with promoters appealing to members of ethnic or religious groups to which they portray themselves as belonging.
