Why Can’t You Set up Shop on Facebook?

You know that brilliant $1 million business idea you’ve been carrying around in your head for years? You know, the one that would surely start a revolution if only you were rich and had the capital resources to launch your own business. Could crowdfunding be your golden ticket?

The idea behind crowdfunding is simple enough—allow startups to raise small amounts of money online in order to fund their burgeoning businesses. Currently startups are prohibited by both federal and state securities laws from raising capital through social networking sites. While it’s received support from the House of Representatives and the president, the crowdfunding movement has stalled in the Senate due to major concerns over security and fraud.

Let’s break down some details on how crowdfunding would work. Imagine you're a startup, with little to no capital to get your company up and running. And let’s say that securing a loan from the bank is out, as your credit is shot. Alternative lending is tempting, but the interest rates are too high for you to take on. What if you could open a Facebook page dedicated to your idea and ask your friends to donate to your business on the Web? As the law stands today, you can’t. To do so would be illegal.

In November the House of Representatives passed the Entrepreneur Access to Capital Act with a vote of 407-17, which would allow startups to “crowdfund” – or raise capital via the Web. President Obama also showed his support of the initiative in his "Startup America" legislative agenda in early February.

Over the past several weeks the Senate has held hearings on two bills that focus on crowdfunding, the Democratizing Access to Capital Act of 2011  which was introduced by Sen. Scott Brown (R-MA), and the CROWDFUND Act which was penned by Sen. Jeff Merkley (D-OR). According to Beltway insiders, both of these measures differ from the House Bill.

The Small Business & Entrepreneurship Council is pro-crowdfunding and has been working to get a spotlight on the issue. Entrepreneur Sherwood Neiss, chief advocate for Startup Exemption , approached the SBE Council last year to ask for the group’s support in advocating for crowdfunding platforms for startup companies.

Neiss said he witnessed firsthand the limited access startups have to capital after winning "Startup Weekend" in Miami, Fla. in 2010 and 2011, but being unable to secure funding for his winning business plans.

Today he works in private equity and his company only invests in about 2.5% of the business plans that are pitched to them. According to Neiss, microfinance models should be used as a blueprint for crowdfunding.

"How are we supposed to create businesses and hire Americans if we don't have the capital to get it done?" he said. "It was out of that frustration that I thought, 'Why don’t we apply the tenants of microfinance to crowdfunding?'" Neiss said. "This is the solution to getting a limited amount of capital to entrepreneurs."

SBE Council President and CEO Karen Kerrigan said the small business advocacy group is lobbying hard to educate Senate lawmakers and Banking Committee members as to how such a model would work to fund startups and create jobs in a sluggish economy. The biggest roadblocks are outdated SEC security laws, Kerrigan said, some dating back to the 1930s.

"Access to capital is such a critical challenge to small businesses," she said. "The framework we have put together for crowdfunding will provide investor protection—we knew fraud would be a problem."

North American Securities Administrators Association Vice President Heath Abshure, also the Arkansas Securities Department commissioner, said the main issue with crowdfunding as it stands is that it lacks balance between the needs of investors and issuers.  The legislation needs to provide more investor protection, said Abshure, who has testified before Congress on this issue.

"The smallest of the small need a way to get to capital," he said. "However, you have to do that in a very reasonable and balanced way."

To start, NASAA would like the issuers, or startups, to provide basic information about their companies including how they are structured, what they are buying by investing and what they will do with the money post-investment. Also, it wants business plans to be provided.

Abshure said a dollar limit should also be set for investors, which NASAA has set at $500. President Obama's proposal caps the investment at $10,000 as does the House Bill, and Kerrigan said the current Senate bills have scaled investment limits based on the investors' income.

States are also the most appropriate regulators for crowdfunding platforms, Abshure said. State regulators have the greatest interest in issuers being successful, he said.

"I have the most interest in seeing businesses right outside my door doing well," he said. "You don't rebuild the economy just by letting more issuers in. If investors don't trust the market, and regulators aren't doing what they need to be doing, they won't invest."

The Small Business & Entrepreneurship Council is working to keep the issue from slipping through the Senate cracks.

"We have to come up with a middle ground so we don't lose momentum," Kerrigan said. "There needs to be a solution now that gives [capital to] businesses with solid plans, that don't have access to capital or venture networks. That gives ordinary Americans the opportunity to invest $100 in a business."

This will help businesses scale and move to the next level, she said, enabling them to buy the buildings, equipment and more that they need to grow.

Abshure agrees, but said without more clear regulations; crowdfunding won't get to that point.

"For people to come out and say that this will be the savior of the economy… it's a risky experiment," he said.