The JOBS Act, the law that allows companies to raise capital via “crowdfunding” for the first time, is appearing more and more in the news. Many people, rather than looking forward to raising capital, are instead raising alarms.
Just to take a couple of examples, The North American Securities Administrators Association (NASAA) called it a danger facing investors, saying the act could “unwittingly open a floodgate of fraud.” And Yves Smith, on her left-of-center blog Naked Capitalism, said the coming fraud would actually raise the cost of capital for small businesses.
These concerns, as you’ll see, are misplaced. But it’s possible these naysayers will have their intended effect—to influence the SEC to pull back on the crowdfunding provisions in the JOBS Act. Not surprisingly, that would help those in the financial centers of power maintain the clubby status quo.
Here’s some background: Crowdfunding allows businesses that have until now been shut out of the capital markets access to funding. It will especially help minority firms, women-owned firms, and community-based businesses, as well as entrepreneurial startups. These are exactly the kind of firms that have had an extraordinarily difficult time raising capital in the current economic downturn.
And the act is likely to result in just what legislators intended: more jobs. According to the U.S. Bureau of Labor Statistics, “4.6 million jobs were created by establishments less than 1 year old, in 2000. In 2010, this number declined to 2.5 million in 2010 —a loss of 2.1 million jobs.” Crowdfunding has the potential to fill that shortfall in job creation.
Concerns about crowdfunding are coming from people who fundamentally misunderstand how crowdfunding and social media work. Let me explain: If you seek to raise money using crowdfunding, the crowd will check you out. They will use all of the new social media tools to validate and verify who you are and what you want to do. And they will alert others—swiftly—if they sense a problem.
Will there be fraud? Probably, but since those providing small businesses capital via crowdfunding are limited in the amount of their income they can place at risk, it would take crowdfunding investors many decades to lose the $5.8 billion that JP Morgan lost in two months. It will take crowdfunding even longer to cause the $19.2 trillion dollar loss, as calculated by the US Treasury, that US public experienced as a result of the financial crisis. Given the huge social benefits that will result, crowdfunding is a risk that we, as a society, can afford to take.
Besides, crowdfunding has been practiced in other parts of the world for at least seven years. What has been the experience with fraud to date? According to one source, “In the seven years crowdfund investing has been legal in Australia and in the two years it has been legal in the UK, no cases of successful fraud have been discovered.”
While they are the first to defend the status quo, few of the financial industry regulators who claim that crowdfunding will unleash a new era of investor fraud have an answer for the question, “What did you do to protect investors in the years leading up to the financial crisis?” In many cases, they were quieter than they should have been about unethical financial services industry practices.
Now, these critics want to make up for their lapses in helping protect investors by badmouthing the one set of tools that might actually get capital to those who can use it to do something worthwhile—those who have been shut out of the capital markets for, well, ever.
Shame on them.
William Michael Cunningham is the author of the forthcoming JOBS Act: Crowdfunding for Small Businesses andStartups, published by Apress. An economist, investment advisor, researcher, and social investing policy analyst, Cunningham can be reached through his websites,www.creativeinvest.com, and www.minorityfinance.com