Regulating Investment Crowdfunding: Small Business Capital Formation and Investor Protection

Investment crowdfunding is a promising solution to the difficulties that small businesses, especially startups, have raising capital. But the capital formation gains promised by crowdfunding come at a cost. Crowdfunding exposes investors, including small, unsophisticated investors who may not appreciate the potential problems, to serious risks of fraud, entrepreneurial self-dealing, illiquidity, and business failure.Regulation may help protect investors, but there’s an unavoidable tradeoff between investor protection and the cost of raising capital through crowdfunding. Excessive regulation will kill crowdfunding by making it too expensive for the small offerings it is meant to facilitate. But excessive investor losses will also kill crowdfunding; if crowdfunding becomes a haven for fraud, the pool of potential investors will dry up.Crowdfunding regulation has a number of possible focal points: the issuers of the securities being sold; the intermediaries through whom those securities are sold; the investors buying the securities. And various types of regulation are possible, including disclosure requirements, investor sophistication requirements, investment limits, due diligence requirements, and resale limitations. This article considers the regulatory choices the United States and Germany have made and discusses how crowdfunding should be regulated.