Will 2014 Be the Big Year for Equity Crowdfunding?

Will 2014 be the year equity crowdfunding arrives in big way for us? Maybe, if we get our act together.

The world's most popular crowdfunding site is Kickstarter, whose pioneering experience highlights crowdfunding's huge upside potential, as well as its downside risk. Kickstarter started out as a site for creatives producing artistic works like movies to raise resources over the Internet. Soon consumer technology companies began preselling proposed new products so they could raise the resources to actually develop them. Successful crowdfunding campaigns have raised from tens of thousands to over a million dollars for new product launches.

Here's the trick though: Raising resources is one thing; delivering on the promise for a new innovation is another. While many new product launches on Kickstarter are successful, a high enough percentage are running into serious problems that it is hurting Kickstarter's credibility. So the Kickstarter founders are returning to their roots as a site for creatives to raise resources to produce art, not new products.

Equity crowdfunding is the ability to raise capital over the Internet by selling stock. While equity crowdfunding is already popular around the world, until very recently it was illegal in the United States outside of an expensive and highly regulated initial public offering process. IPOs are unrealistic for most entrepreneurs who are limited to raising capital through private placements to people they already know through "preexisting relationships." Most of the people entrepreneurs can raise money from have to be "accredited investors," but most entrepreneurs don't know enough individuals with the required net worth of over a million dollars not counting their primary residence.

The JOBS Act passed by Congress in 2012 makes equity crowdfunding legal in the U.S. The Securities and Exchange Commission doesn't like crowdfunding because they focus on the downside of investors being ripped off. The SEC issued enabling crowdfunding regulations in September 2013, but with restrictions so onerous few entrepreneurs will be able to conduct crowdfunded offerings.

Equity crowdfunding has the potential to be huge with the right infrastructure, but it isn't a panacea to the problems of entrepreneurs raising capital themselves. Even though it is possible to sell securities over the Internet, an entrepreneur actually closing the sale of securities to someone he doesn't already know is a different matter. AngelList, where equity crowdfunding can be done today, recently published a success story of an startup entrepreneur who began with an investment from a successful serial entrepreneur he knew in Silicon Valley. This investor introduced the startup to many of his Silicon Valley friends who ultimately invested close to $2 million. The problem with this approach for most of us is that we don't know a successful serial entrepreneur in Silicon Valley to start with.

Twenty years ago I was doing a form of equity crowdfunding way before it was cool. I founded Capital Insights to raise capital for entrepreneurs, starting with a small group of fifteen wealthy individual investors. We identified around a thousand people we knew who were also accredited individuals and asked if they would be interested in receiving information from us about investment opportunities. A few hundred said yes, which created the preexisting relationship we needed to share private placements with them. Over four years we raised around $15 million from 150 wealthy individuals. AngelList and Capital Insights both worked, but solo entrepreneurs can't replicate them.

A big lesson of both Kickstarter and Capital Insights is that as hard as it seems to raise resources, someone has to follow up over time to make sure the promises are kept. Capital Insights most successful investment by far was Earth Fare, which grew into the country's largest regional organic grocery store chain. It was over eight years from the time we first invested to getting the last of our proceeds from selling the company. Failing to execute a product launch may get you sued by an angry early customer. Screwing up an equity crowdfunding campaign risks violating a securities law and going to jail.

The most successful crowdfunding models are built around starting with who you know and proactively working out from there to people you don't know. 2014 can be the year equity crowdfunding arrives in big way, if we put the infrastructure in place to do it right.