Crowdfunding to take a leap by seeking investors

WASHINGTON -- Crowdfunding is about to go big time.

For years, filmmakers, artists and charities have used the power of the Internet to generate money for projects. But in the coming year, with the blessing of Congress, startups will be allowed to raise money this way by selling stock to small-time investors.

For those investors, it's a chance to make a small profit and possibly get in early on the next Twitter or Facebook. But it's also extremely risky, given that a majority of startups fail. And critics warn that investment crowdfunding is ripe for fraud.

The Securities and Exchange Commission on Wednesday took a step toward implementing the law by proposing how much people could invest and how much companies must divulge. The SEC voted 5-0 to send the proposal out for public comment. Final rules could be approved next year.

Under the proposal, people with annual income and net worth of less than $100,000 could invest a maximum of 5 percent of their yearly income. Those with higher incomes could invest up to 10 percent. Companies also would be required to provide information to prospective investors about their business plan and financial condition, as well as a list of their officers, directors and those who own at least 20 percent of the company.

"There is a great deal of excitement in the marketplace" over crowdfunding, SEC Chairman Mary Jo White said before the vote. "We want this market to thrive, in a safe manner for investors."

Crowdfunding is hardly new. Sites like Kickstarter and Indiegogo have for years helped fund projects through donations raised online. Through those sites and others, supporters can pledge $10 -- or tens of thousands of dollars -- to help start a project, be it a business, a charity or the arts. In return, supporters can receive a gift, such as a T-shirt or a song named after them. Others simply feel satisfied knowing that they helped a good cause.

Or some get to join Spike Lee courtside at a New York Knicks basketball game. That's how Lee rewarded donors who gave the maximum of $10,000 to his latest film project, which he funded through a Kickstarter campaign in July that raised $1.4 million.

And soon, businesses will be able to offer investors a piece of their company. The 2012 law, known as the JOBS Act, made it legal for small companies to sell stock over the Internet. They could raise a maximum of $1 million a year from individual investors without registering with the SEC. The SEC was given some discretion to request company information and limits on investment, which they did with Wednesday's proposed rule.

The goal of the law was to help startups raise money quickly when they couldn't attract attention from venture capitalists or traditional investors. At the same time, the law eased the SEC's regulatory reach by giving the startups an exemption from filing rules. The rationale was that new businesses in a hurry to raise money would be hampered by having to submit paperwork. That's a change for Congress, which only two years earlier gave the SEC regulatory powers in response to the 2008 crisis.

Supporters say investment crowdfunding could be a boon to the economy. More businesses create more jobs and that boosts economic growth. And many of the companies that would benefit are in overlooked areas of the country, such as the Midwest or Southeast, according to Robert Hoskins, who does public relations and marketing for crowdfunding ventures.

"It's going to save America's butt," he said.

Mat Dellorso runs WealthForge, a company that will serve as an exchange for startup companies to sell their stock online. He predicts that as much as $300 billion a year could be raised online by startups. He's already heard from more than 500 firms in a broad range of fields, including technology, medicine, energy and consumer products.

But investor advocates and other critics express concerns that this new arena of investing could be a breeding ground for fraud.

While many companies are started by entrepreneurs with good intentions, "there could be some sharks out there as well," said William Beatty, the director of securities in Washington state. "I hope a lot of people don't get hurt," he said in a telephone interview.

SEC Commissioner Luis Aguilar said unscrupulous operators could use investment crowdfunding to prey on "vulnerable segments of society." The system could enable "affinity fraud," he said, with promoters appealing to members of ethnic or religious groups to which they portray themselves as being members.