A new crowdfunding mechanism launched and regulated by the government allows anyone to be an equity investor in a small business or startup. The model is part of the JOBS Act (Jumpstart Our Business Startups) that was originally signed in 2012, but it was only on Monday, May 16 that startups were allowed to raise money from non-accredited investors.
The model, called equity crowdfunding, has been followed with a combination of anticipation and caution – offering an intriguing new capital stream but also concerns about the onerous regulatory framework and the education necessary for businesses and investors to utilize it.
“For the first time in over 80 years, small business in America can raise money from regular people,” said Georgia P. Quinn, a securities lawyer with Ellenoff Grossman & Schole LLP and an expert on equity crowdfunding. “Rather than having to go to institutions or venture capital firms or high net-worth individuals, they can go to their customers, families, friends and social network and raise money for their business.”
Previously with crowdfunding sites like Kickstarter and Indiegogo, businesses could only offer products and rewards for backers who donated money. Under the JOBS Act, businesses can now offer equity stakes in their companies or other types of securities. Businesses must accept investments through SEC-approved online crowdfunding platforms, a number of which are already online.
Companies are allowed to raise a maximum of $1 million through crowdfunding over a 12-month period. Non-accredited investors (people with less than $1 million in net worth and who earn less than $200,000 annually) can invest $2,000 or more per year with a company. These investors are allowed to spend no more than 5% or 10% of their annual income or net worth on crowdfunding (depending on if they make less or more than $100,000 per year).
Equity crowdfunding is already available to accredited investors (people with net worth of $1 million or annual income of $200,000 or more) thanks to Title II of the JOBS Act, which went into effect in 2013. This most current provision of the JOBS Act which covers non-accredited investors is termed Title III.
Equity crowdfunding is regulated by the SEC, and there are major requirements in place for companies to participate, such as highly detailed disclosure forms. “There is no way an entrepreneur or a small-business owner will be able to figure out all these regulations and comply with them,” said Quinn, who helped launch iDisclose.com, a Web-based application that helps entrepreneurs prepare disclosure and other legal documents.
Chance Barnett, CEO of Crowdfunder.com, worries that the high cost of compliance and fundraising (on average $50,000-$100,000 just for a successful campaign) will discourage top startups from exploring this avenue of funding. “A good portion of them are not doing that, given the time, the cost and some of the risks involved,” said Barnett, whose company allows investors to join venture-capital backed deals. Barnett noted that Title II investing with accredited investors is far more flexible from a regulatory standpoint, and that the SEC overreached in protecting everyday investors. “The moment that you touch non-accredited investors,” he added, “you’re subject to a whole new set of onerous things just to raise capital in small increments.”
The regulations are necessary to weed out fraudulent entities and maintain a sense of order, argued Michael Rasmussen, a securities attorney who previously worked at a regulatory agency. “I think it makes the rules of the game clear and levels the playing field for everybody,” said Rasmussen, who consults with brokerage firms through his law firm RAS LAW, LLC. “Yes, it’s burdensome, and yes it’s going to take time and cost money, but that’s the price you have to pay for an efficient market.”
Under the regulations, entrepreneurs are allowed to appeal to consumers and fans through social media and various forms of advertising, online or otherwise. However, on these mediums companies can only convey limited information, including a description of their business, the amount of money they are raising and the type of securities they are offering. Further detailed communications between companies and potential investors must take place on the regulated crowdfunding portals or through broker-dealers.
The morning after the launch of equity crowdfunding, Quinn said there were already nine accepted platforms and 21 live deals with companies. Experts predict a gradual but steady ramp-up of activity as crowdfunding platforms flood the market and both entrepreneurs and investors acquire a growing awareness. “There’s a tremendous amount of enthusiasm to invest, and a lot of folks that are interested in a wide range of opportunities,” said Damon D’Amore, CEO of CrowdFunnel, a site that allows investors to find equity crowdfunding opportunities and offers businesses marketing services to differentiate themselves as they search for investors.
“We do find there is a lot of education that needs to be put forth to the investor market, especially non-accredited investors, because many people don’t understand the opportunity even when they have an opportunity,” D’Amore said.
Even with some of the hurdles, Barnett still estimated that equity crowdfunding will raise roughly $500-$800 million this year and will continue to double for the next three-five years. The government’s hope for Title III is that it gives the American public a new way to invest while offering startups a way to access financing that wasn’t available before.
But what companies are best suited for this financing? Terry White, founder and CEO of WOLACO (Way of Life Athletic Co.), a crowdfunded e-commerce athletic apparel company, believes that pre-revenue entrepreneurs with just an idea can look to Kickstarter and the like. Once startups have an established customer base, he adds, equity crowdfunding makes more sense. The more loyal the community, the greater the potential for customers to buy in. “For early stage companies that are between one-three years ‘in,’” White says, “this community empowerment could be exactly what is needed to build much-needed momentum.”
Experts see other potential rewards in equity crowdfunding. Rasmussen thinks it will be beneficial to startups who can dictate the terms of equity financing as opposed to being at the mercy of high net-worth individuals. Others believe it will open up opportunities that before were only available to entrepreneurs with Silicon Valley connections or who fit certain demographics. “By broadening the base of who’s able to invest, if everybody can invest,” said Quinn, “you’re fundamentally going to change the types of companies that are going to receive financing.”