Crowdfunding Could Democratize Startup Investment by Selling Shares to Donors

SEATTLE, WASHINGTON —  Crowdfunding websites have grown rapidly as a way to raise money for creative ventures, everything from movies to scientific research to clever inventions. People with an idea for a project invite supporters to pool their money via online platforms with names such as Kickstarter, Indiegogo or Rockethub.

Using those same platforms to sell shares in a startup is illegal in the United States, but that might not be the case for long.

Pillow party

Here's a story of small business in the Internet Age. Five years ago, Roberto Hoyos of Seattle founded a company to make what he describes as "geeky" pillows.

"The whole thing really kind of started to impress a girl," Hoyos said. "I actually made a gift of throw pillows that looked like computer icons."

Hoyos' grandmother, a Peruvian immigrant, was a seamstress who taught him to sew at a young age and he inherited her vintage 1954 sewing machine. On this particular day, he puts it to work in his living room, assembling colorful pillows in the shape of chat bubbles.

Now, Hoyos is ready to take his business, named Throwboy, to the next level.

"Where we're able, you know, to get into stores and be on every couch," he said.

He wants to finance a production run in China, but this is where Hoyos bumps into a familiar hurdle for budding entrepreneurs. He has a promising product, but no collateral and no big investors to finance expansion.

"When the business types find out that behind the scenes it's really just one guy doing this, they stop taking it seriously," Hoyos said.

Crowdfunding

So he turned to the Internet, recording a video pitch to raise money from the public on the Kickstarter website.

"With your support," he said on the video, "I know Throwboy can grow into something bigger."

In the crowd-funding arena, supporters who pledge money are, technically speaking, backers not investors. Hoyos promises to reward his backers with pillows. If the business tanks, at least they’ve got a few pillows. If Throwboy becomes wildly successful, they’ve got...a few pillows.

"For my money, I'd like to get a piece of the upside if the company does well," said attorney Cyrus Habib, who advises startups and also serves in the Washington state legislature.

In April, he introduced a bill to expand crowdfunding by allowing local companies to offer equity in an enterprise to potential local shareholders. Just a couple of other U.S. states--Kansas and Georgia--and a few European countries, allow the practice now. What Habib envisions is entrepreneurs collecting small amounts of money, no more than $1,000 or $2,000 at a time, from a large number of people.

Democratizing investment

He sees this as "democratizing" startup investment.

"You know we all wonder, 'Geez, I wish I could have gotten involved with Facebook when it was a start up.' Well, good luck with that," Habib said. "You've really got to be a multi-millionaire to have those kinds of opportunities. What this does is it just opens that sort of thing up to the average Joe."

The U.S. Congress has already directed federal regulators to legalize equity crowdfunding. But rulemaking at the Securities and Exchange Commission has fallen way behind schedule. That's partly why Habib wants to proceed with a state exemption to the usual hoops and hurdles for selling shares.

Bill Beatty is all for moving ahead with caution. He's in charge of securities oversight at the state level at Washington's Department of Financial Institutions.

Beatty worries crooks could use online share offers to cheat people, pointing to some of the come-ons already crowding e-mail in-boxes.

He says the challenge is to strike the right balance between simplicity, oversight and sufficient disclosure of risks to protect investors.

"We want to keep it simple," Beatty said. "The entrepreneur probably doesn't have the resources to know how to write some kind of document that fairly puts the investor on notice about what the risks are. How do we accomplish that?"

Regulators in Sweden, Finland, Germany and the United Kingdom have allowed a handful of equity crowdfunding platforms to launch and solicit investors. Initial ventures to get funded include an online flea market, a distillery in London, and several renewable energy companies.

American entrepreneurs must wait to take advantage. But, even when it's legal in the U.S., pillow company founder Hoyos says he's not sure he'd sell stock to raise money. He says he's happy to reward backers with pillows, but isn't sure he wants to answer to hundreds of small shareholders.