Crowdsourcing Startups

Law Opens Financing of Start-Ups to Crowds

Monica Almeida/The New York Times

Todd DiPaola, far right, and his brother are starting a Web site, ForeFund Capital, as a platform for real estate investment. He expressed enthusiasm about the JOBS Act.

By JENNA WORTHAM

Published: September 22, 2013

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Entrepreneurs looking to the crowd to finance their big ideas just got a little extra help from the government.

It Takes a Village

Kickstarter and Indiegogo are two of the most popular crowdfunding sites, and each has raised millions for start-ups looking to bring concepts to market, ranging from iPad accessories to pop-up wedding chapels. Below, two notable projects.

Kickstarter

Pebble Smartwatch

Before Apple and Samsung announced plans to market smartwatches, Pebble built a watch that connected to a user's iPhone or Android device via Bluetooth, and featured Internet-connected apps, including messaging and distance calculators.

• Money Raised: $10,266,845 of $100,000 goal.

Indiegogo

Ubuntu Edge

The crowdfunding site's biggest campaign to date, the Edge was advertised as the next generation of personal computing, merging a smartphone and desktop PC built on top of the Ubuntu open-source platform.

• Money Raised: $12,814,196 of $32,000,000 goal.

Related

• Success of Crowdfunding Puts Pressure on Entrepreneurs (September 18, 2012)

• Start-Ups Look to the Crowd (April 30, 2012)

• State of the Art: Embracing the Mothers of Invention (January 26, 2012)

More Tech Coverage

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On Twitter: @nytimesbits.

On Monday, federal legislation goes into effect to allow small start-ups to ask for equity investments publicly, such as through social media sites or elsewhere on the Internet, without having to register the shares for public trading. Business owners will now be able to raise any amount, though only, at this point, from “accredited investors” — those deemed wealthy and sophisticated enough to understand and withstand risk.

The legislation is part of the 2012 “Jumpstart Our Business Start-ups Act,” or JOBS Act, meant to encourage the growth of new businesses. Entrepreneurs say it will address a central problem they face: that raising significant capital often depends on having personal connections to investors. Under prior rules, this had to be done privately until a business was ready to enter the public markets.

“How many entrepreneurs are there across the U.S., even in the Midwest, who have these great ideas but no way to tap into that capital?” said Todd Dipaola, an entrepreneur in Venice, Calif. His start-up, ForeFund Capital, is a would-be platform to let real estate entrepreneurs raise money from potential investors.

But others, including noted tech investors like Fred Wilson and Rick Webb, are less optimistic. While the part of the law that becomes effective on Monday deals with asking for investment from accredited investors, a second part — not yet effective — would permit “crowdfunding” from the general public.

Mr. Wilson and Mr. Webb warn that by at least in part deregulating the raising of equity investment, the legislation has the potential to unleash a cascade of abuses by luring investors to what may be risky and untenable business ventures. And some critics have questioned whether such crowdfunding will even help entrepreneurs, because if a company raises more than $500,000 from unaccredited investors it will have to produce audited financial records — a significant expense for a young business.

The JOBS Act has stirred up criticism for its revisions to other laws, including changes that allow hedge funds to advertise to the public for the first time. In addition, Twitter’s paradoxical post this month that it had filed secretive plans to go public was possible under the JOBS Act because the definition of the law deems Twitter, which has hundreds of employees and 200 million users, small enough to file an I.P.O. without publicly disclosing details about the business.

The original laws regulating how equity investments are raised date to the 1930s, and were put in place to “prevent the snake oil salesman from bankrupting the trusting and unassuming grandma,” said Ajay K. Agrawal, a professor of entrepreneurship at the University of Toronto. With the new measures, he said, it will be a tough challenge to make sure any boomlet of crowdfunding ventures does not result in fraud and ordinary people being cheated.

Mr. Dipaola of ForeFund, and his partner, who is his brother, Neil Dipaola, said they planned to mitigate risk by doing background checks on the people they let post on their site to check for any fraudulent or criminal histories.

The new law does include safeguards, given its restriction to accredited investors (people with a personal net worth of more than $1 million or who make more than $200,000 in annual income).

Eventually, however, a revision that is expected to be approved will lower the restrictions around the definition of an accredited investor, meaning more of the public will have a chance of investing their own money into companies that they believe could be as big and successful as Facebook or Twitter.

Although it is not yet known when that will happen, Mr. Agrawal said it could lead to “the wild west” in crowdfunding.

Most people are familiar with the idea of crowdfunding through sites like Kickstarter and Indiegogo, which have made headlines for helping average Joes and Janes drum up attention for their ideas and raise thousands, sometimes millions, to finance them. But financing through those sites differs from what the new JOBS Act provision allows, in that the sites solicit donations, not equity investments.

Occasionally, the people who pledge money to back projects listed on these sites get a “reward,” or a tangible memento in return for their contributions. For example, people who gave $99 to support the Pebble smartwatch project on Kickstarter were promised a device fresh off the assembly line.

Kickstarter, founded in 2009, says close to $800 million has been pledged to about 115,000 projects on the site. But some projects have raised large amounts of money and struggled to produce their promised goods or services, although it is difficult to say exactly what the failure rate is. Kickstarter does not share details of either the success or failure rate of projects financed through its site.

One problem for the crowdfunding sites has been that getting the money is often the easiest part. It is another matter to turn the rosy projections of business success into reality, especially with a crowd keeping an eagle eye on the progress. The Pebble watch, for example, had problems in production that delayed shipments by weeks. Another Kickstarter project, started in 2010 to make lock-picking sets, is still struggling to manufacture and ship sets to those who donated money to receive one.

Also, if entrepreneurs and small-business owners suddenly get a rush of money, they may not be prepared for the demands of managing expectations among their investors.

For equity-based crowdfunding, the challenges could be much greater, particularly because the public is not likely to be used to traditional investment timelines and will expect financial returns quickly.

Mr. Agrawal cautioned that it was far too early to predict whether the new crowdfunding rules in the JOBS Act would succeed in nurturing new businesses, or create new problems.

The slow rollout of the various provisions in the act, he said, “gives everybody a chance to figure this out.”

Slava Rubin, the chief executive of Indiegogo, which lets musicians, artists, and techies take donations to finance one-of-a-kind projects, said the new law could unlock a whole new wave of business.

“You eliminate the gatekeepers and the crowd gets to decide what gets funded,” he said.

People like the Dipaola brothers, who have waited for more than a year for the revisions contained in the law to go into effect, are thrilled. They say the law represents a new era of entrepreneurship in the United States.

“Monday is the day they fire a starting gun at the beginning of a race,” Todd Dipaola said. “And we’re off.”

This article has been revised to reflect the following correction:
Correction: September 23, 2013
An earlier version of this article misstated the number of Kickstarter projects that have received pledges of financing. It is about 115,000, not “nearly 50,000,” which is the number of successfully financed projects.
This article has been revised to reflect the following correction:
Correction: September 23, 2013
An earlier version of this article conflated some separate provisions of the JOBS Act. The part of the law that went into effect on Monday allows start-ups to ask for equity investments without registering shares for sale, but only from accredited investors. It would not be able to solicit investment from anyone. A second part of the law, not yet effective, would allow start-ups to seek investment from ordinary investors through crowdfunding, and would require any company that raised more than $500,000 from such investors to produce audited financial records. Because the companies cannot yet raise equity investment from ordinary investors, it is not the case that they must produce audited financial records for investments of more than $500,000 from that source.

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New York Times

Law Opens Financing of Start-Ups to Crowds