It’s usually associated with making movies, recording music or creating a new product, but the Internet phenomenon known as “crowdfunding” could soon apply to small business investments in Illinois.
State lawmakers are considering a bill to allow small companies to informally issue stocks, following a bipartisan federal law that lifted a decades-old ban on such activity.
Typically, crowdfunding refers to collecting small donations from a large group of people. It has been used through websites like Kickstarter.com to fund video game development, film production, gadget design and even the creation of political action committees. However, it can also mean collecting investments – not donations – for a company.
Michael Lucci, director of jobs and growth at the Illinois Policy Institute, says that in the early days of American capitalism, it was common for small businesses to raise money from many investors.
“Henry Ford financed Ford (Motor Company) this way,” Lucci said. “He went door-to-door and said, ‘This is my pitch.’ ”
The practice was sharply curtailed during the 1930s as part of the response to the speculative excesses that helped cause the Great Depression.
In 2012, facing an economy struggling to recover from recession, the U.S. Congress passed the JOBS Act, which stands for “Jumpstarting Our Business Startups.” Among other provisions, the law allowed small businesses to raise funds from investors without registering with the U.S. Securities and Exchange Commission.
“The bottom line is that an entrepreneur would be able to sell a percentage of her company or a debt interest in her company in order to raise cash, which is the same concept as stocks and bonds,” Lucci said.
The SEC, which is tasked with creating regulations to implement the JOBS Act, has yet to adopt its final rules. However, states can pass laws allowing crowdfunding within their own borders.
House Bill 3429 does just that in Illinois. The bill passed the Illinois House in mid-April and awaits approval from the Illinois Senate. If adopted, the bill would allow companies to create online “portals” for other businesses to sell financial stakes in themselves.
Accredited investors – a regulatory term which includes banks, certain businesses and individuals with a net worth of more than $1 million – could invest as much as they want in businesses seeking crowdfunding. Non-accredited investors would be limited to investing $5,000 per year. Businesses that provide audited financial statements could sell up to $4 million in stocks per year, while those businesses without such statements could sell up to $2 million.
Lucci says 11 other states have already adopted similar laws. He points to Indiana as a failed experiment in crowdfunding, saying that state’s limits on investments were set too low for any meaningful fundraising. Illinois’ version, he says, would have higher limits on how much a business could raise through crowdfunding.
While HB3429 has broad bipartisan support and no organizations registered opposition to the bill during legislative committees in the Illinois House, the federal version of the bill aroused suspicion from consumer groups like the AARP.
Barbara Roper, director of investor protection for the Consumer Federation of America, says crowdfunding of businesses is “fundamentally different” from, for example, donating money to help a band record an album.
“The issue with crowdfunding is that it makes it possible for financially unsophisticated individuals to invest in risky startup companies based on limited information,” she said.
Although Roper was not familiar with the crowdfunding proposal in Illinois, she says that there is a large potential for fraud in crowdfunding because new investors can be easily tricked or convinced to contribute to a bad idea. She says most small businesses fail, for a variety of reasons.
“Even with no fraud,” Roper said, “most people who invest in these companies will lose some or all of their money.”
Lucci responds that Illinois’ version of crowdfunding for businesses has a built-in protection by limiting contributions from non-accredited investors, which typically have less capacity to absorb losses. He says the online portals will have a vested interest in preventing fraud because it’s bad for their business. However, he says the most meaningful protection against fraud is “the power of the crowd.”
“There will be hundreds or thousands of eyes scouring the offerings for fraud once there are healthy portals going,” he said.
Henry Haupt, spokesman for the Office of the Illinois Secretary of State, says the office’s Securities Division has taken a neutral position on the bill. The division, tasked with regulating investing in Illinois, worked with House sponsor Rep. Carol Sente, D-Vernon Hills, to make some changes to the legislation. Haupt says the division doesn’t anticipate any trouble with regulating crowdfunding if the bill passes.
Roper says businesses that want to raise money from crwodfunding “ought to be at a stage where they can meet the requirements for seeking investors.”
“I hope I’m wrong. I hope it turns out better than I expect,” she said. “But we’ve had so many experiments with this that didn’t turn out too well.”
Contact Patrick Yeagle at firstname.lastname@example.org.
This story has been corrected to reflect that the limit for offerings by companies with audited financial statements is $4 million, with a limit of $2 million for those without audited statements. The story previously listed them as $5 million and $3 million, respectively.