Crowdfunding: Progress or Pitfall?

Apr 23, 2012

Entrepreneurs all over the country are buzzing about crowdfunding. A new federal law will make it possible for small companies to attract investors online. But not everyone in Connecticut is thrilled about the new rules. WNPR’s Harriet Jones reports.

Earlier this month President Obama signed into law the JOBS Act, a measure with rare bipartisan support.

“Because of this bill, startups and small business will now have access to a big new pool of potential investors, namely, the American people. For the first time, ordinary Americans will be able to go online and invest in entrepreneurs they believe in.”

For hundreds of thousands of tiny enterprises all over the country, this is an exciting prospect.

“One of the hardest things a biotechnology company – I’m sure any small company – but in particular a biotechnology company faces, especially one involved in therapeutics, is financing.”

Paul Hallenbeck is the CEO of Synbody Biotechnology, a startup that’s just moved to Farmington. He’s focused on developing new cancer therapies, a costly process that can eat up as much as 100 million dollars before a treatment comes to market. So far, Synbody has backing from the state’s tech investment agency Connecticut Innovations. But, says Hallenbeck – they’re always looking for the next dollar.

“We think if we were to tell our story, essentially to the public, would they not be interested in helping a cancer therapeutics company?  This is something you can follow, this is something you can be involved in, this is a real tangible thing that we’re doing.”

Under the new law, Synbody and other startups just like it can offer the public the chance to invest in their company through a crowdfunding website, all at the click of a button. Matthew Nemerson, President of the Connecticut Technology Council, says this new law could potentially speed up the pace of innovation.

“I think what we’re really doing here is reducing some of what have become very onerous costs of going public. And I think we’re looking at pools literally of billions of dollars around the country and around the world that are looking for new technology to invest in.”

It’s very difficult for unproven companies with no revenues to get funding from a conventional bank loan, so in the past, tech startups have tended to look to angel investors and venture capitalists for backing. Danny Briere is a serial entrepreneur and now head of Startup Connecticut.

“You could find a lot of funding in Silicon Valley, lot in New York City. Certain pockets of the nation, there’s a lot of money flowing because they have very strong ecosystems. However if you’re out in the rural parts of Connecticut, you’re up in Litchfield looking for money, there’s not as many venture capitalists walking down the street.”

This legislation, he says, levels that particular geographical playing field for Connecticut companies. But not everyone’s excited about the idea.

“Where there’s no regulatory review, it invites the type of people that would commit fraud.”

That’s Connecticut’s Commissioner of Banking, Howard Pitkin. He’s worried that alongside the many genuine startups, there will be scam artists.

“Well, the problem with fraud is that we can’t get involved until we can see it and prove it. But one thing’s for sure – the money’s gone by then.”

In fact, in the past, startup companies have been able to appeal to the public for cash using Internet funding sites, but that money was more or less a donation – companies weren’t allowed to offer shares in the company and the prospect of a return on people’s investment. If they wanted to do that, they had to have a formal share prospectus reviewed by state and federal regulators, including the Securities Exchange Commission, who would make sure they were disclosing the potential risks that investors might lose all of their cash. Now Pitkin is worried that people who aren’t particularly sophisticated about investing will be tempted to sink money into companies they know nothing about.

“I can’t blame the Congress so much. They are obviously trying to balance consumer protection in this law with the need for creating jobs, which is immediate. So we are understanding of what the Congress did, we’re just not real thrilled with the result.”

Danny Briere at Startup Connecticut agrees that people need to be aware that this is a risky business. You might be excited to get in on the ground floor of the next Apple or Google, but venture capitalists who usually fund these kind of enterprises vet companies rigorously, and even they don’t expect more than about three in ten of their picks to pay off.

“These companies that are being funded by crowdfunders are more likely to fail than ones that go through the normal channels. And what that means is that it’s more of a crapshoot, so you should never invest anything you can’t afford to lose.”

But he says there are controls in place in the legislation. Crowdfunding websites that will act as the go-betweens will be required to register with the SEC, and people who earn less than $100,000 a year will be limited to an investment of $2,000 or less.

“The least amount of disclosure required is at the low end of investment, when you’re asking for a low amount of money, from people that say, wow, you know what, I’d love to play in this startup thing. I’ve never done it before but I’ve got two thousand dollars to invest. I’ll go ahead and give it a shot.”

The SEC now has nine months to write the guidelines to set out exactly how this legislation will work. Both startups and regulators hope the bureaucrats can walk the line between investor risk and economic return.

For WNPR, I'm Harriet Jones.