The U.S. Securities and Exchange Commission has the delicate task of writing guidelines for the next generation of crowdfunding, so that investors are protected and yet preserving its benefits to companies seeking to raise mone y.
Crowdfunding has been mostly restricted to artists and business owners accepting small donations in exchange for things like tote bags and CDs. But the JOBS Act, signed last month, will let entrepreneurs sell pieces of their business (equity) to non-accredited investors via crowdfunding. The SEC is expected to release its guidelines early next year.
The crowdfunding industry has its own recommendations for keeping investors safe without handicapping entrepreneurs. Here's a wish-list from RocketHub, a crowdfunding platform which counts small-business owners as its fastest-growing group of customers and plans to roll out an equity-based product in 2013 (contingent on the final SEC regulations).
Related: Bank Lending to Small Business Slips, Crowdfunding on the Rise
1. Look at more than just credit scores when vetting business owners. A primary criticism of selling equity via crowdfunding is that it could open the door to scammers. Therefore, business owners would need to undergo background checks. But one concern is that ultra-rigorous requirements could stifle the industry. For example, don't require a business owner to have a super-high credit score to be eligible. A student fresh out of college likely hasn’t had much time to build up a credit score, but he or she might have the makings of a star-studded entrepreneur. “Look at this fundraising as what it is: the ability for folks who are underserved by the traditional funding arms to use crowdfunding as their funding solution,” says Meece.
2. No plastic. An investor should not be able to buy a share of a company with a credit card. They allow an eager investor to inadvertently get in over his or her head.
Related: Crowdfunding's Wild West Awaits a Stampede
3. Limit investors' ability to back out to only 24 hours. The Act includes a provision to protect investors’ right to rescind their investment. But one drawback is that fraudsters could dump money into a company, making it seem desirable, only to pull out once others have piled in. What's more, investors could pull out right before a company’s project window closes, effectively spiking the project. As an alternative, one solution could be a 24-hour window to hold an investment in a “pending” state while the investor considers the purchase, after which the investment becomes irreversible.
4. Protect entrepreneur’s use of social media. A clause of the Act prevents entrepreneurs from advertising the terms of a deal, such as the price per share, allowing them only to direct potential investors to particular websites. The concern is that the provision could be interpreted to limit entrepreneur’s access to social media.
“Crowdfunding starts within a community and it spreads, ripples through social media. Social media is a beautiful communication tool,” says Meece. “Without the ability of these campaigns to spread organically through communities, crowdfunding as we know it won’t exist.”
Related: Want to Raise Money With Crowdfunding? Consider These Tips
This article originally posted on Entrepreneur.com