For small business owners and entrepreneurs to build, grow, and support their business, it takes capital, and today, many of these individuals are choosing alternative forms of capital. One popular avenue is crowdfunding. Crowdfunding systems enable users to make investments in various types of projects and ventures, often in small amounts, outside of a regulated exchange, using online social media platforms that facilitate direct interaction between investors as well as with the individual(s) raising funds.”1 There are three basic types of crowdfunding. Money is given in exchange for a clearly defined good (reward), a piece of the venture (equity), or a loan agreement (peer-to-peer). Typically, these three types of crowdfunding occur on different types of websites or platforms. Today, crowdfunding is steadily reaching critical mass as it is now estimated to be worth $3 billion to $5 billion worldwide.2
Despite the growth of crowdfunding in the alternative lending landscape, one major crowdfunding method remains untapped. Equity-based crowdfunding was created under Title III of the Jumpstart Our Business Startups (JOBS) Act (2012), but the rule under Title III is still being written at the Securities and Exchange Commission (SEC) to expand the ability for entrepreneurs to sell equity to prospective investors online. Until the SEC issues final rules under Title III, equity-based crowdfunding for the vast majority of Americans remains off-limits.
While only 5 percent of all crowdfunding globally is equity-based, new regulations may shift this trend.3 Currently, 16 states are working on their own rules to regulate equity-based crowdfunding as the SEC continues to deliberate on federal rules.4 Small business owners have a special interest in these upcoming regulations because they could alter the funding landscape and close the gap between the amount of capital desired and the amount of capital a small business can actually acquire.
In the Joint Small Business Credit Survey Report, 2014, there is evidence that small businesses relative to their larger counterparts continue to struggle to obtain their desired capital via traditional credit applications (Figure 1).5 Additionally, FDIC Call Report data shows that the availability of small loans has steadily decreased as a proportion of the total amount of nonfarm, nonresidential commercial loans by loan balance (Figure 2). As a result, the small loans (often less than $1 million) that startups and small businesses often desire are more difficult to attain.
Equity-based crowdfunding could create an efficient alternative for small businesses and microbusinesses which are unable to attain their desired level of credit in an environment where the amount of small business loans being made available is shrinking. Although the future is impossible to predict, research into potential small business outcomes of equity-based crowdfunding is warranted.
In order to further understand the impacts of the proposed SEC rules and how equity-based crowdfunding may affect entrepreneurs, investors, and the economy, this brief will review current policy, equity-based crowdfunding issues, and two distinct case studies of equity-based crowdfunding platforms.
Download the entire Issue Brief: Equity-based Crowdfunding: Potential Implications for Small Business Capital
1. Agrawal, Ajay; Catalini, Christian; and Goldfarb, Avi. “The Geography of Crowdfunding.” National Bureau of Economic Research. 2011. http://www.nber.org/papers/w16820.pdf.
2. TD Economics. “Crowdfunding: A Kick Starter for Startups.” 2014. http://www.td.com/document/PDF/economics/special/Crowdfunding.pdf.
3. Mollick, Ethan. “The dynamics of crowdfunding: An exploratory study.” Journal of Business Venturing. 2013.
4. Jefferson Public Radio. “Crowdfunding Investments Take Shape in Oregon.” 2014. http://ijpr.org/post/crowdfunding-investments-take-shape-oregon.
5. Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia. “Joint Small Business Credit Report, 2014.” 2015. http://www.newyorkfed.org/smallbusiness/SBCS-2014-Report.pdf.
