Chapter 1
Tapping a New Source of Business Funding
In This Chapter
The concept of crowdfund investing goes back to 3000 b.c.; it was one of the earliest forms of financing. Back then, banks and financial institutions didnât exist, but people with money and people who needed funds did. Deals were made among people who knew each other, and accountability was reinforced through interaction and oversight. The rates of return (interest rates) were determined by how well the individuals knew each other and how much money someone needed. The weaker the connection and/or the more money needed, the riskier the investment was and the higher the return had to be.
In the early days of our nation, the crowd concept was evident in the way the Statue of Liberty was erected (through contributions from the citizens of France and the United States) and in the proliferation of building and loan associations that helped community members mortgage homes. But federal regulations changed drastically following the stock market crash of 1929, and the crowd largely got squeezed out of the private equity marketplace.
In this chapter, we explain why this form of financing is ânew all over againâ and has become one of the hottest topics in early-stage Âbusiness financing. We walk you through the industry framework we took to Washington and explain how crowdfund investing changes the business financing landscape.
www.dummies.com/inaday/crowdfundinvesting.The Origins of the JOBS Act
The groundwork for the JOBS Act, which opened the door to crowdfund investment, was laid with the 2008 financial collapse. After past recessions, small businesses got the country back on track. But this time around, they couldnât do so because the typical ways that small businesses gained access to capital had dried up. Banks werenât lending, credit card companies slashed credit limits and hiked interest rates, and private equity and venture capital firms invest money in less than 2 percent of companies that approach them.
Many people and organizations still had cash after the 2008 collapse, but that money wasnât flowing to the entrepreneurs who could use it to start businesses and to small businesses that could create jobs.
The three of us could see the problem clearly, and we offered a solution. We had zero political experience, yet we were able to get a crowdfund investing bill passed in the U.S. Congress in 460 days â from the creation of our Startup Exemption Regulatory Framework to the day we attended the presidential signing ceremony in the Rose Garden of the White House.
In this section, we briefly explain why we were (and are) so bullish on crowdfund investing and why the time was exactly right for the U.S. financial regulatory system to allow it to happen.
Internet + social media = easy crowd access
Virtually every business today has to have an online presence. People spend an increasing amount of their time online, and that includes time they spend shopping, investing, and making other business-related decisions. Therefore, it just made sense to introduce the means for entrepreneurs and small businesses to raise funds online and for individual investors to locate such investment opportunities via their online social networks.
Responding to the financial Âcollapse of 2008
After the financial collapse of 2008, small business funding dried up. If you were a small business owner or entrepreneur and you went into a bank for a loan, the bank would require three years of financial statements, as well as enough assets to back your loan. If you were trying to fund a startup, meeting these requirements was impossible. (As a brand-new business, where would the financial statements come from?) And even if you were a going concern, the asset requirement likely took you out of the running for the size of loan you really needed.
Credit card financing was no longer a readily accessible option either. Credit card interest rates were raised to extremes, and credit limits were slashed. (You can argue all day about whether this was a good or bad thing, given how addicted our nation was to easy credit, but it had a net negative effect on even successful small business owners.)
Recognizing that investors want other options
Before the JOBS Act, the average small investor didnât fund small businesses and startups. Federal financial regulations made doing so tough, and unless your nephew or college roommate or another close contact was the one opening the business, chances are, you would have no way of hearing about this type of investment opportunity.
But after 2008, many people lost trust in the traditional financial systems. They stopped putting blind faith in big companies, big banks, and Wall Street. They still wanted to invest their money in businesses, but they didnât want the people responsible for the global meltdown to take a cut of the pie.
With the advent of crowdfund investing, the average small investor today can sit in her living room anywhere in the world, study 20 different pitches from 20 different entrepreneurs or small business owners, decide which of them make sense for her, and fund them with the click of a mouse. And she can feel assured that, when doing so, her funds are directly supporting the individual making the pitch â not a multinational financial conglomerate that couldnât care less about the $100 or $500 or whatever amount sheâs investing.
Following in the footsteps of microfinance
In many ways, Mohammed Yunis, the father of microfinance, laid the foundation for crowdfund investing. Microfinance focuses on small loans, typically in the $300 to $500 range, to entrepreneurs (mainly women) in the developing world.
The core tenets of microfinance and crowdfund investing are similar: Both systems are about getting capital in the hands of people who have trouble raising it via traditional means, so those people can start and grow their businesses. Yunis made his first microfinance loan in 1976, and shortly afterward he started the Grameen Bank, the worldâs first microfinance organization. (He and the bank won the Nobel Peace Prize in 2006.) Microfinance has since grown to be a factor in almost every developing country in the world and has had an amazing impact on alleviating poverty.
Following the path blazed by Yunis, in 2005, Matt Flannery and Jessica Jackley launched Kiva (
www.kiva.org), which allows someone with as little as $25 to make a loan to an entrepreneur in the developing world. Kiva connects with microfinance organizations in the developing world, which locate entrepreneurs and help write their stories and explain why they need the money. Then it allows donors to become part of a crowd that supports an entrepreneurâs mission.Since Kiva began, it has funded over $300 million in loans with a 98 percent repayment rate â far better than credit card companies have in the developed world. (Because the organization is a 503(c), the SEC allows for the principal of the loan to be repaid.) The site is a platform where anyone with an Internet connection and a debit card can sign on and make a loan.
www.kiva.org) and click on Lend. Read just a handful of stories that demonstrate who benefits from these microloans. We dare you not to feel inspired!Watching the rise of donation- and perks-based crowdfunding
Out of microfinance and Kiva sprouted donation- and perks-based crowdfunding websites. When they first began, these sites mainly supported art-related projects. If a band wanted to make a new album, for example, it created a profile on a crowdfunding website, posted some of its past music, and talked about its plans for the new album. Then it listed how much money it needed and how it planned to use the money. The band created a bundle of rewards that donors/investors would r...