There is a lot of excitement, intrigue and confusion swirling around the issue of crowdfunding, which uses the power of social media to raise capital. Some call it the democratization of capital, others see a messy and inefficient regulatory system that may well prevent its success. While some enthusiastically watch as websites like Kickstarter and Indiegogo raise thousands, and sometimes millions, of dollars through the crowd, others fear that easier access to investors via the Internet will encourage the posting of fraudulent projects that could trick unsavvy investors, who may lack disposable income, out of their money. For better or worse, most agree with the claim that investing or donating through the Internet is fundamentally changing the landscape of start-up finance. What is apparent for the community economic justice movement, and the Green-Collar Communities Clinic’s (GC3) work, is that crowdfunding has the potential to create resilient, local economies by allowing small businesses and entrepreneurs to raise capital from neighbors who choose to invest in their local businesses.
The current crowdfunding websites, such as Kickstarter and Indiegogo, have already demonstrated the power of people to advertise their ideas online and garner significant support from the community to fund their endeavors. This new form of advertising has the potential to transform not only donation-based fundraising, but also local investing and small business financing. But a host of issues often go unrecognized or at least not addressed by both attorneys and non-attorneys alike: the legal framework underpinning these online portals; why currently they can only offer donation-based opportunities where investors are not offered a financial return; why average-income people are not able to choose where to directly invest their money, thus left to placing their money in retirement or pooled money market accounts that typically avoid investing in local businesses; and why small businesses face difficult barriers to traditional financing in the first place. Without providing an exhaustive history of securities law the answers to these issues find their roots in the U.S. Securities and Exchange Commission (SEC)’s mission to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” The SEC is charged with both protecting investors and the market, while also creating avenues for raising capital and managing financial markets. On balance, the agency has interpreted its mission as favoring big business over small, and, in the name of investor protection, excluding (or at minimum strongly discouraging) low-income investors.
For example, if you wanted to open a small grocery store in a low-income neighborhood to provide a healthier alternative (or in some cases the only alternative) to fast food franchises and corner stores and you needed more financing, the current regulatory system would likely prevent you from approaching your neighbor to invest if she is not already an accredited investor. An accredited investor must have annual income in excess of $250,000 or $1 million net worth (excluding your home). Translated, these requirements mean that only 3% of the population is qualified to invest directly in their local store! Walking into a bank hoping to convince a banker to provide a loan would also be very difficult, as banks do not often lend to just a merely good idea, with no history of success, even more so if the store is to be located in a traditionally low-income neighborhood. Your two remaining options would be to either convince a wealthy investor to help finance the business or to raise donations on a website like Indiegogo, both of which take a lot of luck.
In the Jumpstart Our Business Startups (JOBS) Act, Congress tried to remedy these constraints imposed by the regulatory system by directing the SEC to draft a crowdfunding exemption to allow funding portals, including Internet websites, to offer investments to the public. In an ideal setting, an exemption from securities law would allow lower- and middle-income individuals to pool their capital through equity, debt, or other financing mechanisms and fund start-up businesses that will positively impact their communities. By utilizing an online funding portal such as Kickstarter, rather than merely providing philanthropy, these community members could receive a return on their investment, have control over where their money flows and generate capital in their community. In short, if your neighbors wanted to invest in your grocery store, they could.
Through this lens, crowdfunding does offer the potential to democratize capital and open small investment opportunities. However, most academics and scholars agree that the exemption is so focused on investor and market protection that it will not be able to achieve this goal. The JOBS Act was micro-legislated, meaning that Congress included specific provisions that the SEC must implement, such as: individuals with an annual income or net worth less than $100,000 can only invest up to $2000 or 5% of their annual income or net worth; those with annual income or net worth over $100,000 may not invest in excess of 10% of their annual income or net worth, not to exceed a maximum aggregate investment of $100,000; the requirement that businesses targeting offerings of more than $500,000 require audited financial statements; and, that the funding portals be highly regulated and approved by the SEC. Many agree that this level of investor protection would make it cost prohibitive for small businesses and the portals to comply. However, until the regulations are announced, we cannot gauge their actual effect.
In the meantime there is an already-existing, perhaps even more effective, method to raise small capital investments for your grocery store idea. A direct public offering (DPO) is a state-based offering that is exempt from compliance with federal securities law because the offering takes place solely within one state. A DPO allows start-ups to sell securities directly to the public without the use of an intermediary, which would otherwise help deter fraud and protect investors. California calls a DPO “qualification by permit” and, once approved, the startup can publicly advertise the investment opportunity through a variety of channels including the Internet and newspapers. While the offering is limited to in-state investors, some people argue that the DPO has fewer restrictions overall and may be a more effective capital-raising mechanism than the anticipated crowdfunding exemption.
A DPO may allow you to realize your grocery store dream through raising small investments from the community and leverage the buying power of the residents of your state. In fact, People’s Community Market (PCM) is doing just that, raising over $325,000 to date. PCM seeks to open West Oakland’s first full service grocery store in over a decade. West Oakland is a predominantly African American and Latino community with an overabundance of liquor stores and mini-marts, but no comprehensive fresh food market. The neighborhood’s 25,0000 residents must travel over a mile to reach the nearest Pak n’ Save or Safeway discount market. PCM’s mission is to bring fresh foods and groceries as well as a “health resource center and community hub . . . that supports local families to attain healthier and more socially connected lives.” By offering investments through a DPO, PCM is allowing the neighborhood to choose where their money goes, help build a much-needed grocery market in the community, and become founding investors in the store.
Some people may question whether a public interest law practice such as GC3 should include providing assistance to businesses that seek to raise start-up capital from their community. This sentiment seems rooted in the fact that much of the legal profession’s pro bono services focus on litigation, where the need for assistance is often more obvious and direct, and the results are more easily observed. Certainly some may legitimately question whether raising $300,000 or even $1 million is genuinely a public interest activity. Yet, the power of local business development to allow one’s capital to remain in the community, where community-based entrepreneurs have the power to launch a business, create stable employment and even provide ownership opportunities, is vital for the creation of thriving, productive, and healthy communities. Thus, the power and promise of crowdfunding can be harnessed and directed to serve the mission of community-based economic justice practices such as GC3.
Law Clerk, Green Collar Communities Clinic