When people hear the words crowdfunding, they usually think of sites such as Kickstarter, where hundreds of backers collectively fund artistic projects with donations in exchange for various related rewards and a first crack at the project before the general public. But there's another version of crowdfunding on the horizon and this one is of the investment variety: Equity crowdfunding.
"This version sees investors put money in exchange for equity in your company because there's upside when you succeed," says Ethan Mollick, an assistant professor of management at the University of Pennsylvania's Wharton School of Business, who has studied crowd-funding models extensively.
Equity crowdfunding has been legal in the UK for two years and in Australia for seven and though it's made significant in roads in North America, it is still awaiting legalization here. The real buzz about the possibility of legalization began when the U.S. Congress passed the Jumpstart Our Business Startups Act in April 2012. The law is designed to encourage funding of startups and small businesses by easing regulations and making it easier for individuals to invest. It directs the Securities and Exchange Commission to spell out the legal rules for exempting equity crowdfunding from regulation by 2014 -- a feat the SEC is currently discussing.
Following the American example, provincial securities commissions in Canada -- most notably the Ontario Securities Commission -- are now tabling discussion and feedback from the public and small business organizations on what a crowdfunding exemption in the province may look like.
"The OSC extended its comment period on Consultation Paper 45-710 Considerations for New Capital Raising Prospectus Exemptions until March 8, 2013 and will review all feedback received before making any determinations," said an Ontario Securities Commission spokesperson.
Some of that feedback has encouraged the OSC to move quickly on implementing the crowdfunding exemption, as research shows only 17 per cent of small to medium-sized businesses (SMEs) are able to raise venture capital and secure angel investment. Quick action in terms of crowdfunding will help address this funding gap without business owners turning to similar opportunities internationally -- something the OSC won't be able regulate.
However, there's also a strong call to balance portal efficiency with investor protection against fraud.
"The concern here is that you can lose your money, so the point of these meetings will have to be making sure there are protections against fraud," says Mollick.
The North American Securities Administrators Association [NASAA] listed equity crowdfunding on its list of Top 10 Investor Threats, even though, in the seven years that it has been legal in Australia and in the two years it has been legal in the UK, not a single case of fraud has occurred.
The same goes for the traditional Kickstarter model. Mollick believes this is because of the sense of community the model creates and the accountability it fosters. In his recommendation letter to the SEC, Mollick wrote that for equity crowdfunding to work this sense of community must remain.
"Also, you want to make sure that no one's risking too much of their money, you want to make sure that people have a plan for how they're going to spend the cash, you want to make sure there's accountability in the long-term and you want to make sure no one's soliciting money using misleading statements," he says. "A lot of this stuff exists in current securities law, it's just a question of how to create an opening without ruining current securities law."
Aaron Broverman is a Toronto-based freelance writer