Crowdfunding Can Help Build Business, But At What Cost? The Securities and Exchange Commission is poised to let small businesses get financed by the masses. Investing in startups is risky, though. Meanwhile, critics are wary of regulation.

Crowdfunding Can Help Build Business, But At What Cost?

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STEVE INSKEEP, HOST:

One tough challenge for a startup business is raising money. That could soon get easier. The Securities and Exchange Commission is about to approve rules allowing small businesses to use crowdfunding networks to sell stock to investors. The rules are generating controversy and some members of Congress want to rewrite them. NPR's Jim Zarroli reports.

JIM ZARROLI, BYLINE: When Andy Krasfur opened Spira Footwear a dozen years ago he raised money the way a lot of entrepreneurs do. He reached out to friends and family. When the economy tanked that became a lot harder.

ANDY KRASFUR: The pool of people that you can go to has shrunken significantly and everybody goes to those same people.

ZARROLI: Then Krasfur found a crowdfunding website that helped his cash flow enormously. He was able to tap into a huge network of new customers. They sent him money. He sent them discounted shoes.

KRASFUR: Kind of the way I looked at it was your customer becomes your bank and your customer.

ZARROLI: Over time Krasfur has used the site to sell about 6,000 pairs of athletic shoes bringing in about a half million dollars.

KRASFUR: It's a fundamental game changer in my world, for me.

ZARROLI: The website Krasfur used is called rockethub.com and it's based here in New York's garment district. Chief financial officer Alon Hillel-Tuch says that since 2009 RocketHub has helped numerous small businesses raise money.

ALON HILLEL-TUCH: Tens of thousands, this is the best way to put it. On a good day we have anywhere from 450 to 600 projects launching.

ZARROLI: Sites like RocketHub work by connecting entrepreneurs with potential customers all over the country. And soon life is going to change drastically for these sites. Under rules written by the Securities and Exchange Commission businesses will be able to use crowdfunding to sell stock, says law professor Mercer Bullard of the University of Mississippi.

MERCER BULLARD: You will be able to go online, review a company yourself, and if you like it push a button and invest and receive stock in that company in return.

ZARROLI: The new rules grew out of the Jobs Act which, in a rare act of bipartisanship, was passed by Congress two years ago and signed into law by President Obama. But the rules remain controversial. Bullard notes that crowdfunding sites will be allowed to reach out to a whole new class of investors.

BULLARD: No matter what your income or net worth you're guaranteed to be able to invest at least $2,000. If you are the retired widow living on social security and you've managed to save $100,000 in your bank account, you can put $10,000 of that into crowd-funding every year.

ZARROLI: And he says a lot of these people are going to lose money.

BULLARD: We know from statistics how many new businesses are going to fail and if you assume that crowdfunding investments are just like any other you're looking at a quarter to a third of them failing within a couple of years.

ZARROLI: The SEC has struggled to write rules that will protect small investors and also unleash the potential of crowdfunding. But the results are already generating criticism from both sides. Alabama Congressman Spencer Bachus addressed SEC Chair Mary Jo White at a hearing last month.

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ZARROLI: At RocketHub, Alon Hillel-Tuch says regulators have imposed strict auditing requirements on companies that use crowdfunding. And he says that's too big a financial burden for startup businesses. He also says crowdfunding sites need protection against investor lawsuits or they'll have to get expensive liability insurance. And he says that will ultimately have to be paid for the small businesses that use the sites.

HILLEL-TUCH: It's a very unfortunate thing because what you're actually doing is, you're limiting the rate at which we're able to domestically innovate and expand and in essence create jobs, right?

ZARROLI: Some members of Congress have called for rewriting the Jobs Act to address such concerns. But such a move is likely to face stiff opposition from consumer groups. For all its promises, crowdfunding poses risks to investors. The next few months will begin to show how big those risks really are. Jim Zarroli, NPR News, New York.

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