HBR Blog Network | by Larry Downes | October 28, 2013

The crowdfunding service Kickstarter reached an important milestone last week. The company’s website reported that Kickstarter has now funded over 50,000 projects, with pledges coming from over 5,000,000 individual backers. Since its founding in 2009, Kickstarter has helped fledgling projects raise nearly $1 billion in donations.

But those impressive numbers may be eclipsed by a revolution in venture financing that is only being held back by final government approval: start-ups raising actual investment funds from individuals in exchange for equity or a share of profits.

Last week, the U.S. Securities and Exchange Commission took a major step toward allowing crowdfunded equity financing.  In a 600-page proposed rulemaking, the SEC moved to implement key provisions of the 2012 Jumpstart our Business Startups Act (or JOBS Act). Passed by a large bi-partisan majority of Congress, the JOBS Act directed the agency to simplify many aspects of corporate fundraising and initial public offerings, and to enable individual investors to participate in equity campaigns for small startups.

Related:  Canadian Resources for Proposed US Equity Crowdfunding Rules

How big a deal is this “democratization” of finance? In a recent HBR article, Paul Nunes and I introduced the term Big Bang Disruption to signify innovations that, thanks to rapidly advancing technology, come out of the box both better and cheaper than alternative solutions already in the marketplace. These upstarts don’t just bedevil incumbents –- they blow them away.  Crowdfunded equity financing has the potential to do that.

To understand why, consider how crowdfunding works today. Up until now, at least in the U.S., services such as Kickstarter (and others including Indiegogo and Rockethub) have operated on a donation model. Organizers determine a minimal level of funding they need to bring the project to fruition, and establish premiums associated with different levels of contribution. Backers promise to support proposed projects in exchange for the premiums, which become more generous as pledge levels go higher. If the project goal is reached, Kickstarter collects the pledges from backers, taking a 5% cut before turning over the proceeds to the organizers.

The old approach, characterized by secretive and proprietary internal projects, is being challenged by a crowd-based model based on cloud computing, large-scale databases, and the exploding availability of off-the-shelf hardware and software components.  New products, services, and companies are created virtually, build their supply chains in the cloud, and connect with early customers through social media.

Tapping the power of the Internet, crowdfunding has proven wildly successful. Kickstarter funds everything from art to food to fashion, films, and hardware. I recently pledged $40 to support the development of the Polar stylus, a self-assembling modular pen made up largely of magnets. In exchange for my pledge, I will receive a silver-plated Polar pen from the start-up’s second production run. The compelling campaign video demonstrating the different ways the pen could be configured and used went viral.  Polar’s Canadian organizers wanted to raise $14,000, but instead received pledges of over $500,000 from over 14,000 backers, all in a matter of weeks.

As Paul and I look into the forces driving Big Bang Disruption (as research for our forthcoming book), we see crowdfunding as a key element behind a dramatic change in research and development.

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