When ‘Friending’ Becomes a Source of Start-Up Funds

When ‘Friending’ Becomes a Source of Start-Up Funds

Social networking is pretty good for keeping abreast of far-flung friends. Could it work for entrepreneurs looking for investors?  That’s the question Sarah E. Needleman and Angus Loten pose over at the Wall Street Journal Small Business blog.

Critics say the idea is dangerous for investors, and even dicey for the entrepreneurs. Yet, it is gaining traction with small-business owners from the Bay Area to New York, who say they eagerly await an opportunity to sell stakes in their businesses through social networking—a process known as crowd funding.

The House Financial Services committee last week backed legislation that would make it possible for small businesses to use crowd funding to raise money from investors in exchange for equity stakes.

Under the proposal, investors would be able to buy stakes of up to $10,000 a year, or 10% of their annual income, whichever is less. Companies would be able to sell up to $2 million in equity—but must provide audited financial statements if the total exceeds $1 million.

If approved, the legislation might augur a big change in the status quo, and critics urge caution:

“This is tailor-made for Internet fraud,” says Mercer Bullard, a law professor at the University of Mississippi who testified against the bill before the House panel in September. The measure would allow someone living solely on Social Security to invest $1,500 in an unregistered offering sold through a website that wasn’t subject to regulation as a broker, he says.

The measure could also prove problematic for entrepreneurs. Most small businesses lack the resources to deal with outside stakeholders.

“I wouldn’t see this as a boon for small business, because there’s a lot attached to that money,” says John Torrens, who teaches entrepreneurship at the Whitman School of Management at Syracuse University in upstate New York. For example, entrepreneurs would need to manage cash flow for dividend payments, he says. Owners with outside shareholders are often forced to “take their eye off the ball” of day-to-day operations.

Related article:

A Split in the Crowd Funding Crowd

. . . and poll:

Should privately held businesses be allowed to sell equity stakes to people they find on crowdfunding sites?