Is Crowdfunding a Good Way to Invest in Startups?
Crowdfunding (also known as crowd financing) describes the collective effort of individuals who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations. Originally used to support microfinance, non-profit organizations, and aspiring artists, crowdfunding became a source of funding for new businesses after the passage of the Jumpstart Our Business Startups Act (more commonly known as the JOBS Act) in 2012, which allowed small private companies to sell equity directly to investors. Although the JOBS bill passed with overwhelming bipartisan support, it was opposed by the AARP, the Consumer Federation of America, the Council of Institutional Investors, and a number of securities regulators. They argued that the loosening of investment protections would expose small and inexperienced investors to fraud.
While the possibility of hitting the jackpot by investing a small amount of money in a startup via the Internet is enervating and compelling, I have to side with the regulators on this one. The risk of fraud is just too great. To cite an example, the State of Massachusetts recently charged two out-of-state oil & gas companies with fraudulent securities sales. The principals of the two companies had been subject to securities orders in other states revoking their use of private-placement exemptions. And one of the companies allegedly employed a cold-caller who had been found guilty of theft.
The North American Securities Administrators Association (NASAA) said that it had found an explosion in the use of “crowdfunding” online. “An analysis of Internet domain names by state and Canadian securities regulators found nearly 8,800 domains with ‘crowdfunding’ in their name as of Nov. 30, up from fewer than 900 at the beginning of the year,” NASAA said in a statement. About 6,800 of those domains have appeared since April 2012, when the JOBS Act was signed into law.
“Investors soon can expect to be inundated with crowdfunding pitches, legitimate or otherwise,” said Heath Abshure, NASAA president and Arkansas securities commissioner, in the statement. Although many sites have been established by credible organizations, there are those that appear to have been created by individuals operating out of their basements. This is not to suggest that you should avoid any investment opportunity offered through crowdfunding. But as with any investment, make sure to complete your due diligence. And remember the adage: if it sounds too good to be true, it probably is!