Regulations Keep Poor From Financing The American Dream

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Dennis Cakert Sharing Economy Fellow, Americans for Tax Reform
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Low and middle income Americans can crowdfund the Bernie Sanders campaign, but not their own businesses.

After defeating Hillary Clinton in Wisconsin, Sanders turned to the crowd and said “We have up to this point in the campaign received over six million individual campaign contributions. Anyone here know what the average contribution is?” To which the crowd roared back: “Twenty seven dollars!”

The Sanders campaign clearly demonstrates the power crowdfunding gives to low and middle income Americans who share a common interest. But if the same low and middle income Americans who fund the Sanders campaign use a peer to peer network to pool resources and start a business, they would be in violation of federal law.

An accredited investor must demonstrate a “pre-existing” relationship with the borrower or have a net worth of at least $1 million, excluding the value of a principle residence, or an annual income of at least $200,000 for a single or $300,000 for a married couple. If these conditions cannot be met, which is probably true for most Sanders supporters, the investment is only considered a donation and individuals are denied ownership in the business.

Before these regulations were put in force, there were many instances of low and middle income Americans pooling their resources to start a business and realize the American dream. Ford, the B&O Railroad and Metlife Insurance are examples of businesses that started from crowdfunding and eventually grew into economic powerhouses. The freedom to associate and invest gave them the necessary capital to get their business off the ground.

Peer to peer networks expand on this freedom by vastly increasing the number of people who can come together to own a business. The peer to peer platforms act as a middleman to connect individuals from across the country. An entrepreneur simply logs on, fills out an application and customized loans are generated and displayed side by side for easy comparison. On the flip side, an investor can log on and search for appealing business ideas to invest in. The ease and flexibility of the process greatly reduces transaction costs and allows an individual to invest as little as $25. Once the loan is completely funded, the entrepreneur provides an e-signature and a monthly payment system is set up for all the parties involved. The process takes around five days to complete.

But financial regulators have cracked down on peer to peer lending supposedly to “protect” low and middle income investors. An individual’s contribution is considered just a donation unless they meet the steep financial requirements to be an accredited investor.

Nowhere is this problem more clearly demonstrated than in the case of Oculus Rift. The virtual reality headset company used peer to peer networks to raise $2.4 million from 9,522 people to get off the ground. However, because of regulations “protecting” investors, the contributions were required by law to be considered donations and individuals were denied equity in the company. When Oculus Rift sold to Facebook for $2 billion, the people who initially helped the company get started were left without compensation. Instead of distributing $2 billion across a broad range of average investors, it was concentrated in the hands of a few already wealthy investors.

Facebook, Oculus Rift and the investors are not at fault. The problem is how the law excludes low and middle income Americans from participating in the market. The regulations are in place to “protect” investors from fraud, but they wall off low and middle income Americans from owning equity in a business. The intent of the regulations is commendable – nobody with a good heart wants to see someone get swindled into investing their retirement into a Ponzi scheme. However, low and middle income Americans are effectively barred from using the power of peer to peer networks to start a business.

If elected officials are as serious about helping the poor as many of them claim to be, they will remove financial barriers and include everyone in the market. The rise of peer to peer lending has tremendous potential for low and middle income Americans to fund their own businesses, but it requires a return to the classic system of free enterprise the country was founded on. Reducing the financial requirements to let more individuals become accredited investors is a good place to start.

Dennis Cakert is Sharing Economy Fellow at Americans for Tax Reform