Clearing Up Confusion Around Crowdfunding

Since the JOBS Act was signed into law almost a year ago, a vigorous debate about the merits of crowdfunding has occurred. There are scores of crowdfunding advocates and entrepreneurs poised to jump into this emerging marketplace as soon as the final rules and regulations are finished, but there are crowdfunding detractors as well who caution that this will be a fraught process.

Steven Rattner, founder of the private equity firm Quadrangle Group, announced that he is no fan of the JOBS Act in the New York Times earlier this week. Mr. Rattner takes issue with many of the JOBS Act's provisions, but singles out the section of the bill commonly referred to as the Title III crowdfunding provisions as particularly troubling. His concerns reflect a misunderstanding of the emerging investment crowdfunding space. I do hope those misunderstandings are quickly resolved so everyone understands that these changes to securities law, if properly executed, are filled with more promise than peril.

Mr. Rattner's first mistake with regard to Title III crowdfunding provisions is the assertion that the JOBS Act is not about employment but rather about loosening the securities laws. While we can debate whether bringing millions of small companies within the domain of S.E.C. regulation really constitutes a "loosening" of the law, it is not up for debate that small and medium businesses are the primary driver of job growth in this country and that they need capital to thrive.

Traditionally, this capital came in the form of bank loans and other institutional forms of investment. Unfortunately, access to this type of capital has diminished for most small businesses, creating a need for alternative sources of funding. Among those alternative sources of funding is investment crowdfunding. While it remains to be seen how effective crowdfunding will be in addressing the need for capital, the logical connection between job creation and investment crowdfunding is clear.

There was also an unfortunate mischaracterization of the type of companies that will participate in crowdfunding. Mr Rattner dismissed them all as "small startups with no track records" as opposed to the "big corporations like Wal-Mart and Exxon" he presumably approves of. While some crowdfunding advocates justify investment crowdfunding with the promise of being able to invest in the next Facebook, high-tech startups are not the only type of company that can or will participate. All types of small and medium sized companies, from small manufacturers to the local coffee shop will be able to utilize crowdfunding.

Concern about the size and age of the companies expected to seek crowdfunding could be dismissed as Wall Street snobbery against Main Street, but that characterization would be unfair. Rather, Mr. Rattner's concern appears to be that investors are going to lack sufficient information about these companies to make an informed investment decision. This is not necessarily the case.

First and most importantly, the S.E.C. can and should mandate robust disclosure on the part of companies seeking crowdfunding. This disclosure of the company's status and prospects will allow investors to make an informed decision and become more sophisticated stewards of their financial future. Second, to the extent investors invest in local companies or companies that they have an affinity for they may be in a position to know a fair amount about the company based on their interactions with it. Finally, let's not forget that investors, including sophisticated investors, often don't know that much about the large companies Mr. Rattner seems to trust. Just ask the investors in Enron and MCI Worldcom.

Crowdfunding, like every other type of investment, is not without risk (though contra Rattner, not as risky as playing the lottery). Crowdfunding also provides significant promise for both the small- and medium-sized companies seeking the capital they need to remain the engine of American job creation. It also gives investors an opportunity to support the companies they care about and a chance to make a reasonable return. If done right, crowdfunding can make a significant and positive impact on the American economic landscape; hopefully financial and investment experts like Rattner will bring their considerable experience to help ensure this happens.