Crowdfunding Bill Would Allow People to Invest in Local Businesses

Under a measure that passed the House last Thursday, you may soon be able to invest in a portfolio of your favorite independent businesses. The bill, which won bipartisan support and cleared the House on a 407-17 vote, would overturn long-standing Securities and Exchange Commission (SEC) rules that make it nearly impossible for small businesses to raise capital (or borrow money) from their customers and communities.

Current SEC rules divide investors into two categories. Wealthy people ("accredited" investors) are assumed to have a certain degree of financial sophistication. Businesses are free to approach them for funding. The rest of us are covered by safeguards that bar businesses from soliciting our investments without registering a public offering of securities with the SEC, an arduous and expensive legal process that is well beyond the reach of a neighborhood restaurant or start-up clothing maker. The current rules do exempt some small investment offerings, but these exemptions are too narrow for most independent businesses to use without running afoul of the law.

The result is that, even as enthusiasm for independent businesses and locally produced goods has grown, the savings of almost all American households remains invested in the stocks and bonds of large corporations. We may buy local, but we invest transnational. There are few alternatives.

Many independent businesses, meanwhile, are short of the capital and credit they need. The rise of giant banks over the last twenty years has sharply reduced the ranks of local banks, making it harder for small businesses to obtain credit. For those that cannot secure a bank loan, but have an avid following, raising funds in small increments from the public can be a viable option. Some that have managed to do so without violating SEC rules, like Greenlight Books (read their story), have also discovered that grassroots financing has it advantages. It helps to build the relationships and community loyalty that can be so critical to surviving in the age of Amazon and Walmart.

Crowdfunding is further along in Europe, where the rules about offering small securities are more generous, according to Amy Cortese, whose new book Locavesting provides an inspiring look at the many ways our investment dollars might be redirected locally. One active platform is the UK-based Funding Circle. Since its inception in August 2010, Funding Circle has facilitated about £15 million ($24 million) in loans to 404 businesses. The site features a list of loan requests that have been vetted by Funding Circle's underwriters and rated according to risk. Individuals can lend to as many as they like. A single loan may involve hundreds of lenders. Lenders are encouraged to join Circles, which are groups of people that have a common investing interest. Many are geographically focused — businesses in Edinburgh or Bristol, for example. So far, there have been two defaults and no cases of fraud.

Hoping to legalize crowdfunding in the U. S., the Sustainable Economies Law Center (SELC) sent a petition to the SEC in July of 2010 requesting that the agency establish an exemption for businesses seeking up to $100,000 with individual investments capped at $100. Although the SEC received more 150 letters of support for the petition, nothing much happened until September of this year, when President Obama endorsed an exemption for crowdfunding and said that he would work with the SEC to change the rules.

Within weeks, Representative Patrick McHenry had organized a committee hearing on the issue and introduced HR2930, which sailed through the House at breakneck speed. The legislation requires the SEC to exempt businesses seeking to raise up to $1 million, with the amount an individual could invest limited to no more than 10 percent of his or her income, a much higher threshold than the SELC proposed. The measure establishes disclosure and other standards for the companies soliciting funding, as well as third-party intermediaries that link borrowers and lenders.

Although the crowdfunding bill won overwhelming support in the House, it faces an uncertain future in the Senate. The SEC opposes the bill, saying it would create too many openings for fraud. But, as some in Congress have noted, it's hard to defer to an agency whose oversight failed to protect investors from Bernie Madoff and a mountain of toxic mortgage-backed securities. "It’s a legitimate concern, but we feel that the regulatory focus should be happening more at the top [of the market], not at the grassroots," says Jenny Kassan, co-director of the SELC.

Another source of opposition is state regulators. Their laws and rules governing offerings under $1 million would be preempted by McHenry's bill. While states play an important role in securities oversight, Kassan says that their specific regulations vary so widely that it's prohibitively expensive for an expanding small business or start-up to comply with 50 different sets of requirements.

Perhaps a more significant concern about McHenry's bill is whether it would allow crowdfunding to stray too far from its community roots. This kind of financing works well when it's grounded in real relationships — when those investing are also the company's suppliers, customers, or neighbors. Nothing in the bill so far requires borrowers and investors to have a connection or something in common beyond the financing (a shared geography, say). Should McHenry's legislation open the way for crowdfunding to become more national, web-based, and anonymous, the risk of defaults and fraud may grow.

Although Kassan, Cortese, and other advocates of community-based crowdfunding share this concern, they say that the legislation is still a good move on balance. As Cortese notes, "This could tap a huge pool of capital for companies that need it, and allow people to invest in companies they love."

• The SELC has posted a list of ways you can get involved in supporting the crowdfunding bill.

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Stacy Mitchell is a senior researcher with the Institute for Local Self-Reliance, where she directs initiatives on independent business and community banking. She is the author of Big-Box Swindle.