Equity Crowdfunding: Good for Capitalism or for Fraudsters?

Will equity crowdfunding generate reams of jobs, or is it a disaster in the making?

Render of a crowdfunding concept
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Crowdfunding so far has involved only "perk-based" platforms, exemplified by Kickstarter, which spokesman Justin Kazmark describes as "the intersection of commerce and patronage." The project can't promise profits, merely a share of the output. The most successful project yet funded by Kickstarter, for example, is the Pebble E-paper wristwatch, which received $10.3 million. Pebble backers get a discount on the $150 watches, but not an equity stake in anything.

"That's very different from raising money to start a business where what you have to do to be successful is produce a profitable business," says Barbara Roper, director of investor protection at the Consumer Federation of America. "It's a much more challenging prospect. With these start-ups, under the best of circumstances, with no fraud, most of them will fail. So you're encouraging unsophisticated investors with minimal money to invest to risk that capital on companies most of which will fail."

But what if investors are fully aware of the risks? "Look at all of the information on investor literacy and tell me how confident you are that they will be fully aware of the risks," says Roper. In a country where people chronically undersave for retirement, she says, "diverting limited resources toward speculative investments is a questionable policy goal."

[Read: Need Income From Your Retirement Funds? Try These.]

Sandlund says other countries prove that crowdfunding can work as advertised with a minimum of fraud. He cites Australia's Small Scale Offerings Board, a crowdfunding platform that since 2007 has raised A$130 million (US$135 million) via 176 offerings. ASSOB chief Paul Niederer says there have no incidents of fraud.

Sandlund also notes that the JOBS Act's crowdfunding provisions include investor restrictions. If you make less than $100,000, for example, you'll be able to invest only $2,000 to $5,000 during any 12-month period (depending on your income) in the offerings of any one issuer. There doesn't seem to be any barrier to investing in more than one offering, though.

Whatever the consequences of crowdfunding, they won't be apparent for a while. Nothing can happen until the SEC issues rules for implementing Title III. They were supposed to be out by December 31, but few expect anything until well into 2013. Then, the Financial Industry Regulatory Authority, which will most likely oversee crowdfunding portals, will have to weigh in.

"They have a vested interest against Title III," says Sandlund, "so there are dynamics at play that are not promising."