Equity Crowdfunding: A Kickstarter for Companies Is Right Around the Corner

Crowdfunding illustration via Shutterstock

Crowdfunding sites have long been a way to successfully raise cash for projects (does Amanda Palmer ring a bell?). But what if there were a Kickstarter for companies? Turns out, that’s right around the corner. The concept is  called “equity crowdfunding,” and we asked MIT Sloan professor Christian Catalini to give us a crash course. He explains via email why equity crowdfunding has everyone from Silicon Valley to Kendall Square buzzing—and what it could for everyday investors.

What exactly is equity crowdfunding?

It allows individuals to invest online in private businesses for a financial return.

How is this different from Kickstarter?

On Kickstarter, all backers need to evaluate is if a project creators’ can deliver on their promises. On (the new) equity platforms, backers become investors. So, they need to consider if there’s a demand for the product: Will it sell? Will it be popular? Will they make a return on their investment?

Depression-era laws barred the sale of securities to directly ask the public to invest in companies. President Obama pushed the 2012 JOBS Act to end the ban and allow equity crowdfunding. Why?

This should release additional capital for entrepreneurs in the economy and potentially spur economic growth and job creation. Since September 23, startups can actively ask for investment in public, using social media or advertisements to attract new investors.

There are limits to start. Wealthy individuals earning $200,000 (or households earning more than $300,000) and with assets of greater than $1 million—“accredited investors”—are getting first crack. Why?

The SEC must balance the desire to expand the scale of equity crowdfunding, which many entrepreneurs and platforms share, with protecting investors. Accredited investors have more investment experience and capital than the general public, so they can take higher risks.

When can someone like me get in?

By allowing only accredited investors, the SEC is essentially creating a phase where we can learn about the pitfalls of equity crowdfunding without putting the general public at risk. Startups are very risky investments. At the same time you could imagine the general public later investing in funds that pool investments from multiple projects to diversify risk.

So, what are the risks?

There are incompetent entrepreneurs who don’t have the ability to deliver on their promises. They may pick bad or too risky projects. In the worst cases, they could be victims of fraud. In all of these cases, they would likely loose all of their investment.

Next up for the SEC is approving Internet portals—the new Kickstarters—so they can be up and running. What do you think they’ll be asked to do to protect people?

We will see a lot of experimentation. It will be interesting to see what kind of data portals will have to collect about the companies, what kind of level of due diligence they will have to perform, and how they will educate the public about the risks of fraud and failure.

Kickstarter is a phenomenon. Will equity crowdfunding be as big?

Equity crowdfunding has the potential of being even bigger, assuming the right rules are set in place for it to succeed. My guess is that we’ll see a lot of experimentation around models that will try to merge traditional offline early-stage investment with online participation (like AngelList’s recent introduction of syndicates). Even if equity crowdfunding were to just tap into the capital of accredited investors, it has the potential of having a major impact on how early-stage finance is done.

This interview has been edited and condensed.