Crowdfunding websites have grown rapidly as a way to raise money for creative ventures — everything from movies to scientific research to clever inventions. You might have heard of Kickstarter, Indiegogo or Rockethub. It would be just a small leap to use those same platforms to sell shares in a startup. That’s illegal right now, but maybe not for long.
Here’s a story of small business in the Internet Age. Five years ago, Roberto Hoyos of Seattle founded a company to make what he describes as “geeky” pillows.
“The whole thing really kind of started to impress a girl,” Hoyos recalls. “I actually made a gift of throw pillows that looked like computer icons.”
Starting a startup
Hoyos says his grandmother was a seamstress. She taught him to sew at a young age. He inherited her vintage 1954 sewing machine… which he now uses in his apartment living room to assemble colorful pillows in the shape of chat bubbles.
Hoyos says he’s ready to take his business - named Throwboy - to the next level. “Where we’re able, you know, to get into stores and be on every couch.”
He says he wants to finance a production run in China. “I want to be able to move Throwboy to do big scale runs instead of one at a time by myself.”
But this is the usual conundrum of a budding entrepreneur with a promising product, but no collateral and no deep pockets to finance expansion.
“When the business types find out that behind the scenes it’s really just one guy doing this, they stop taking it seriously,” Hoyos says.
A new thing non-profit and for-profit enterprises can do is solicit backers via the Internet. Hoyos recorded a video pitch and set a $20,000 fundraising goal on the Kickstarter website.
But this is where it wades into a legal thicket. Supporters who pledge money are — technically speaking — “backers,” not investors. Hoyos promises to reward his backers with pillows. If the business tanks, at least you’ve got a few pillows.
But if the business becomes wildly successful, you get… a few pillows.
IPO for the Average Joe?
“For my money, I’d like to get a piece of the upside if the company does well,” says suburban Seattle attorney Cyrus Habib. He advises startups and also serves in the Washington Legislature. Last month, Representative Habib introduced a bill to expand crowdfunding by allowing local companies to offer equity to potential local shareholders. His is one of two such proposals in Olympia.
This has come up in a few other states, but none other in the West. What Habib envisions is entrepreneurs collecting small amounts of money — no more than $1,000 or $2,000 at a time — from a large number of people. He sees this as “democratizing” startup investment.
“We all wonder, ‘Geez, I wish I could have gotten involved with Facebook when it was a start up.’ Well, good luck with that,” says Habib. “You’ve really got to be a multi-millionaire to have those kinds of opportunities. What this does is it just opens that sort of thing up to the average Joe.”
Congress has already directed federal regulators to legalize equity crowdfunding. But the federal rulemaking at the Securities and Exchange Commission has fallen way behind schedule. That’s partly why Habib wants to proceed with a state exemption to the usual hoops and hurdles for selling shares.
Pros, cons, and risks
Bill Beatty is all for moving ahead with caution. He’s in charge of securities oversight at the state level at Washington’s Department of Financial Institutions. “When people complain about the amount of time it takes to implement and other things, well this is not a small change. This is a BIG change.”
Beatty says he worries crooks could use online share offers to cheat people. Just look at some of the come-ons in your spam folder. He says the challenge is to strike the right balance between simplicity, oversight and sufficient disclosure of risks to protect investors.
“We want to keep it simple,” Beatty says. “The entrepreneur probably doesn’t have the resources to know how to write some kind of document that fairly puts the investor on notice about what the risks are. How do we accomplish that?”
It’s hard to gauge how many Northwest startups would take advantage of a Kickstarter-style sale of shares. Washington’s financial regulators estimate only a small number. But corporate attorney Joe Wallin in Seattle as well as that state representative we met earlier predict a lot of demand.
For now, the issue has been pushed off in the Washington Legislature until 2014. Come that day, pillow company founder Roberto Hoyos says he’s not sure he’d take advantage. He says he’s happy to reward backers with pillows, but he doubts he wants to answer to hundreds of small shareholders.
On the Web:
The Two-Way: Kickstarter’s growing pains (Sept. 21, 2012) - NPR
Throwboy Chat Pillows - Kickstarter
Jumpstart Our Business Startups (JOBS) Act - Securities and Exchange Commission
Potential Dangers of Crowdfunding Investment Opportunities - Washington DFI
The Dangers of Crowdfunding - Better Business Bureau
HB 2023: Crowdfunding for small securities offerings - Washington Legislature
HB 2054: Increasing high-risk capital - Washington Legislature