By Clifford Hwang
Want to drink coffee and play with a cat in DC? You can do that at Crumbs & Whiskers, thanks to a successful fundraising campaign on Kickstarter. People can “invest” in all sorts of campaigns ranging from technological inventions to personal travel trips on a wide variety of platforms including Kickstarter, Indiegogo, or Go Fund Me. Although some campaign starters will promise something in return for investments, these donation-based investments do not allow investors to share in the projects financial success. In other words, investors cannot buy equity in the project or company, which can lead to serious outrage in certain instances.
Often considered a new method of fundraising for small businesses and entrepreneurs, crowdfunding has great potential because it fills the financing gap that bank will not fill. On the other hand, crowdfunding and other internet based financing is susceptible to fraud, especially if the majority of investors are not financially savvy. Cognizant of this potential, many countries around the world have enacted legislation to regulate crowdfunding and give opportunities to investors to buy shares in smaller companies. For example, in the United States, under the SEC’s final crowdfunding rules that will take effect on May 19, 2016, investors will have the ability to buy equity through crowdfunding. In Asia, China will also be regulating crowdfunding platforms. In a few days, Belgium will be one of the first countries to allow crowdfunded securities to trade.
These countries are all trying to maximize potential fundraising with the least amount of regulation while simultaneously attempting to protect investors. There are various ways to pursue this goal, including limiting the amount of investment, more rigorous due diligence, and increased disclosure. In fact, several countries have enacted regulations that limit the amount of funds that can be raised through fundraising and limiting the amount any individual can invest. For example, fundraisers in the United Kingdom can raise up to €5 million, and there are limits on the amount individuals can invest unless they fall under one of the exemptions such as having income in excess €100,000 or net worth of €250,000.
Compared to the United Kingdom, other countries have enacted more conservative and risk adverse regulations. An example of this situation is in China where an investor needs to invest at least £100,000, which would ensure only individuals of high net worth and comparatively more financially savvy would be able to invest. An alternative way to restrict investment is by limiting the capital that can be raised in a given year. Take for example the regulations in France, where companies, without having to issue a prospectus, may only raise up to €100,000 within twelve months and have no more than 150 non-qualified investors. Both in the case of China and France, the authorities are attempting to protect investors, but do so in very different ways.
As of now, it is unclear which approach is correct. If regulation and enforcement are too lax, then there is a great likelihood that fraud will occur. However, if it is too strict, the crowdfunding scheme will be undermined because it will be too burdensome for companies to raise capital. Perhaps more worrisome is if crowdfunding capital dries up because the investments were too risky. As a result, the next several years will be a time of experimentation, during which there will, hopefully, be no disasters that ruin the scheme before it even gets started.