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All I Want for Christmas is… An Equity Stake in a Startup Crowdfunder

This year, I seriously considered doing all my Christmas shopping on crowdfunding site, Kickstarter.

In fact, I found the perfect gift for my nieces via a Kickstarter pitch that went viral.

If you’re unfamiliar with the concept, crowdfunding is basically a group of like-minded people who club together to financially support people, companies, organizations, or movements.

According to research firm Massolution, the crowdfunding market is big business, growing from $1.5 billion in 2011 to $2.8 billion in 2012.

There are three basic types of crowdfunding:

~ Money for Donations/Goods: Kickstarter, as well as most other U.S.-based platforms, falls into this category. It covers a range of projects that people can support, such as films, games, music, fashion, art and technology. Basically, everything must be a project of some kind, with a specific goal. Kickstarter was founded in April 2009, and so far more than 2.5 million people have pledged over $350 million towards 30,000 projects.

In exchange for your contribution, you get a mug, t-shirt and/or perhaps an I.O.U. for the first product off the assembly line. Because you receive goods in exchange for your contribution, you’re considered a consumer, not an investor. This allows Kickstarter, the project leaders and the SEC to keep it simple.

Kickstarter founders, Charles Adler, Perry Chen and Yancey Strickler, are adamant that their utopian marketplace Is! Not! A! Store! But writing in Forbes, one of their industry’s very own, Ryan Caldbeck, founder of CircleUp, called Kickstarter “the Amazon of Crowdfunding.”

Frankly, it’s hard to see it as anything else. When you look at how Kickstarter is structured, you see many similarities between its platform and our motivation for giving gifts:

  • It’s the perfect place to go for my “alpha adopter” friends and family.
  • It’s better than giving lottery tickets, with better chances of a “payoff.”
  • It’s both local and global.
  • Supporting my friend’s band on Kickstarter gives me the same fuzzy feeling I get when I donate to a charity.
  • I get to be a modern day de Medici by funding art and theatre projects I care about.
  • For now, it’s the closest I’ll get to acting like an angel investor (more on this in a minute).

So what about the other types of crowdfunding?

~ Lending: Sites like SoMoLend and 40Billion aggregate funding to startups, while the lenders get back a small percentage of interest. Student loan portals have also made inroads with names like SoFi and CommonBond.

~ Equity: You can guess what goes on here. Platforms like U.K.-based Crowdcube and Bank to the Future (which Richard Branson has backed) accept investment dollars in exchange for equity stakes.

In the United States, loan and equity crowdfunding portals are restricted to “accredited investors” – those with a net worth of $1 million, or an annual income of $200,000 for a string of years.

This has prompted debate among lawmakers, who argue that more people should be able to get involved.

And thanks to the JOBS Act passed in April 2012, accredited investors are about to become irrelevant.

JOBS Act More Transformative Than Dodd-Frank Will Ever Be

In the coming months, private companies will be able to seek funding of up to $1 million per year without having to restrict themselves to accredited investors or the IPO process to get it. And instead of relying on word of mouth to attract investors, private equity will be able to advertise for the first time.

To safeguard the 99%, funding will be limited. Those making less than $100,000 per year will be limited to a $5,000 investment, while those making over $100,000 will have a ceiling of $10,000. In short, regular investors will have more information, access and exposure to investment opportunities than at any time since the Great Depression.

Concerns Over Delays and Fraud Mount

But lest I paint too rosy a picture here, this is the federal government we’re talking about. And that means mistakes, negotiations and bureaucracy are sure to stall the JOBS Act’s implementation.

January will mark Congress’ 270-day deadline for the SEC to wrap up its guidelines and rules on the legislation. But it’s almost a given that the agency will miss the deadline.

The recent departure of SEC chief Mary Schapiro is likely to delay matters further. On the bright side, the SEC has gone on the record saying the JOBS Act takes priority over the Dodd-Frank bill.

Watchdog groups are warily eyeing the rulemaking process for loopholes and fraud.

Frankly, I expect we’ll see abuses that will go undetected for years.

And despite telling investors to do their own due diligence and “let the buyer beware,” you know there will be people who’ll plow their last $5,000 into a “can’t lose” opportunity… and will lose. We’ll then hear about it, complete with outrage and calls for reform.

You heard it here first.

Funding portals will be required to register with the SEC, most likely as a broker-dealer – a process that carries burdensome restrictions on what they can say, how they advertise and how they interact with investors.

Most likely, crowdfunders who are already donation-based will remain that way, simply because they don’t want the added hassle.

With the ongoing potential for fraud, crowdfunding sites will prove their worth by weeding out the unsound deals and providing forums where information will be exchanged, ideas debated and industry expertise shared.

Crowdfunding in 2013

Once the new rules do come into force, crowdfunders will need to innovate or die. Those who succeed will either be “super-niche,” or attract a huge pool of investors by offering a bit of everything. Think of it as your gourmet French chocolates store versus… ahem… Amazon.

Also, look for U.K. platforms to rush into the U.S. market at first, having already worked out the regulatory kinks back home.

So will you be able to shop for investments this time next year? That all depends on how the next few months shape up.

Maybe you’ll be able to invest in your favorite neighborhood restaurant and ask for a gift certificate in your stocking, too. Talk about investing in what you know.

Here at Tech & Innovation Daily, we’ll be tracking the rulemaking and watching for which crowdfunders emerge as early leaders. Not to mention the projects that put them on the map. So stay tuned.

Ahead of the tape,

Elizabeth Carney