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Monday, December 15, 2014

Kickstarting It Old School

Crowdfunding may seem new, but it has a long history


If you’ve been to crowdfunding sites like Kickstarter and Indiegogo, you might think that they are new phenomena, made possible only by the wonder of the Internet. That’s true in part, but crowdfunding actually has a long and proud tradition dating back well before the web was a twinkle in Tim Berners-Lee’s eye.

As my colleague John Berlau details in his new paper, “Declaration of Crowdfunding Independence: Finance of the People, by the People, and for the People,” entrepreneurs and inventors had a long track record in the early part of the last century in seeking funds directly from large groups of interested supporters. Henry Ford, for example, sought funding for his first car from friends, colleagues, and even his lawyer, whose investment of $5,000 in 1903 turned into $12.5 million by 1919.

Indeed, mass solicitations for funding were common among colonial-era entrepreneurs seeking to develop ideas into new ventures. Ben Franklin created a fire department and insurance company using the model in 1752. The insurance giant MetLife was founded by solicitation of policyholders in the 1860s. Railroads — the high-tech start-ups of the early 19th century — routinely raised money from citizens who could expect to use the service.

As the example of Henry Ford’s lawyer shows us, there was a crucial difference between earlier crowdfunding campaigns and today’s web-based equivalents: those who put up money got an investment share in the company rather than simple perks such as T-shirts or downloadable movies.

What happened? To put it simply, the Progressive Era happened. Beginning in the late 1910s, states began to pass laws restricting investment solicitations, based on the idea that people were being lured into turning over their savings for promises of pie in the sky. Progressive reformers wanted to protect vulnerable investors from losing their shirts; some even declared such investment sinful.

As is so often the case, these “Baptists” were accompanied by bootleggers in the form of local banks, who feared they were losing savings accounts to these investments. As Berlau points out, for example,

Kansas Bank Commissioner J.N. Dolley, who pushed through that state legislature the nation’s first “blue sky” law, was a former bank executive who worried openly about deposits being withdrawn for stock offerings. He complained, “The banks hear of such cases because usually the victim draws money out of a bank to buy his wildcat mining shares or his stock in a lunar oil company, or whatever it may be.”

Eventually, the federal government got into the act. It created the Securities and Exchange Commission (SEC) in 1934, which imposed more and more restrictions on how companies could raise money.

SEC rules prevented entrepreneurs from soliciting investment from the public and eventually created the class of the approved “accredited investor,” which turned general investment into a rich man’s pastime. And the reason there are so few peer-to-peer lending operations like Prosper or Lending Club is because the SEC requires that every loan made on peer-to-peer websites submit a separate prospectus or securities filing.

These restrictions on investment, dating from early in the 20th century, are a perfect example of what Competitive Enterprise Institute founder Fred Smith calls the Progressive Era’s derailment of classical liberal evolution.

The good news is the tide can be turned back. And the development of new technologies like peer-to-peer lending and crowdfunding platforms represents the first steps in restoring American finance’s innovative spirit.

Debt and equity crowdfunding afford much greater potential for boosting companies, jobs, and the economy than the current versions of fundraising. Debt-based crowdfunding offers a specific rate of return, while the equity version offers an ownership stake similar to a share of stock and a claim on future profits.

These forms of funding allow a firm to expand quickly. According to a study by Crowdfund Capital Advisers, “While pledge or donation crowdfunding lead[s] to an increase of 24 percent in revenues, equity-based crowdfunding resulted in a quarterly increase of 351 percent[,] not including funds raised via the equity round.” In addition, “87 percent of firms either had [hired] or intended to hire new employees as a direct result of having raised equity or debt financing via crowdfunding.”

Thankfully, some in Washington have noticed these possibilities. The Jumpstart our Business Startups (JOBS) Act, which became law in 2012, has allowed limited investment crowdfunding. The SEC, however, has dragged its feet in issuing regulations pertaining to the liberalization and has taken a more restrictive view than seems to have been Congress’s intent.

The new Congress could go further. It could create a new, high upper limit for crowdfunding offerings and other exemptions from securities laws at $10 million, up from $1 million. The Startup Capital Modernization Act of 2014 (HR 4565), which contains just such a measure, has already been passed out of committee in the House. Congress could also significantly decrease, or abolish, the qualifications necessary to be an “accredited investor.”

The United Kingdom abolished its version of the accredited investor rule in the mid-1980s. That allowed ordinary people to share in the success of the Thatcher-era privatizations, which involved crowdfunding solicitations such as the “Tell Sid” campaign.

If equity crowdfunding worked for Henry Ford, it can work for people today.


  • Iain Murray is the Competitive Enterprise Institute's vice president of strategy. For the past decade with the Institute, he has concentrated on financial regulation, employment and immigration regulation and free market environmentalism.

    Murray has published several acclaimed books, including Stealing You Blind: How Government Fatcats Are Getting Rich Off of You and The Really Inconvenient Truths: Seven Environmental Catastrophes Liberals Won’t Tell You About – Because They Helped Cause Them. His op-eds have appeared in The National Review, The Providence Journal and Fox News. He has appeared on Fox News, CNN Headline News, the BBC and Al-Jazeera, among other broadcast networks.

    In addition to his work at CEI, Murray is the visiting fellow at the Adam Smith Institute and board members of the Cherish Freedom Trust and American Friends of the Taxpayers Alliance and advisory board members of Global Britain and Young Britons Foundation.

    Prior to coming to CEI in 2003, Murray was the Director of Research for the Statistical Assessment Service and an Executive Officer in HM Department of Transport. He received his MBA from the University of London and his MA from the University of Oxford.