How Equity Crowdfunding Could Change Start-Up
After years of waiting, it looks like the gates to equity crowdfunding (EC) will finally be opened thanks to a recent vote within the Securities and Exchange Commission. Although Title III of the Jump-Start Our Business Start-Ups (JOBS) Act was signed into law over three years ago, the SEC has taken this long to draw up rules that would prove mutually beneficial to businesses and investors. While the agreed upon rules, which will allow non-accredited investors to participate in crowdfunding campaigns, still won’t take effect for a bit longer, the news has plenty of entrepreneurs, investors, and crowdfunding websites buzzing about the possibilities of equity crowdfunding.
What is Equity Crowdfunding?
You’ve likely heard of crowdfunding sites like Kickstarter and Indiegogo that have become household names in recent years. These sites have been popular among filmmakers and artists looking to create their projects by offering fans prizes and content in exchange for funding them. Additionally these sites have proven a great way for tech companies to pre-sell their gadgets without spending a fortune to bring their ideas to market.
Equity crowdfunding follows this same basic concept except that those helping to fund a start-up or small business are awarded an actual piece of the company itself. In this way it’s almost more like an IPO except that the shares are not publicly traded and are non-liquid. Since these are investments and not just regular fundraising campaigns, the SEC will oversee all equity crowdfunding under the Title III law.
What are the New Rules?
Part of what took so long for Title III of the JOBS bill to be fully realized was the balance that needed to be struck in order to make equity crowdfunding work for all parties involved. Previous drafts of the regulatory rules were criticized for being either too expensive for businesses to comply with or, on the other end, leading to too much risk for potential investors. The latest set of rules was finally adopted on October 30, 2015 by a vote of 3-1.
SEC will now allow companies to raise up to $1 million a year in Title III funds. Since non-accredited investors will be able to participate, the amount of money that individuals can contribute depends on their income and net worth. Investors with an annual income or net worth less than $100,000 can invest up to $2,000 or five percent (whichever is greater) of their annual income or net worth (whichever is less) per year. If the investor has a net worth upwards of $100,000, they may invest up to 10% of their annual income or net worth (again, whichever is less) in a year.
One drawback of equity crowdfunding for cash-strapped start-ups are the costs associated with getting your campaign off the ground. Originally the rules were set to require companies looking to raise funds through EC to submit to a full audit by the SEC — something that carries a hefty price tag. While that provision has been removed, companies will still have to have their finances scrutinized during their first Title III round, especially if they wish to raise over $100,000. Other expenses such as legal fees and commissions paid to crowdfunding sites need to be factored in as well.
Finally like Kickstarter, if a start-up or small business fails to meet their fundraising goals, all of the money they have collected will be returned to investors. As Entrepreneur points out, this will force business owners to think carefully about how much they should raise in Title III funds. Additionally businesses will not be reimbursed for the money spent on failed campaigns.
Where Can Small Businesses Start Equity Crowdfunding Campaigns?
Even though equity crowdfunding has been a hot topic for some time, no site that allows businesses to run EC campaigns has reached Kickstarter-level notoriety. However, following the passage of Title III, that could be changing. In fact while Kickstarter is apparently not intersted in getting into EC, Slava Rubin, the CEO of Indiegogo, recently told the Chicago Times “All of us at Indiegogo are excited that the SEC is formally expanding the way in which everyone will be able participate in the entrepreneurial ecosystem through the amazing power of crowdfunding. We’re now exploring how equity crowdfunding may play a role in Indiegogo’s business model.”
While Indiegogo and possibly other sites tweak their offerings to accommodate EC, sites like SeedInvest and EquityNet are already built for businesses looking to raise money via equity crowdfunding. In fact EquityNet also helps entrepreneurs determine their valuation and helps to prepare their pitch. A video on the company’s site explains how it works:
With a few months before the Title III rules take effect, it’s likely that we will see other sites similar to EquityNet emerge. Furthermore it’s conceivable that peer to peer lenders such as Lending Club could add equity crowdfunding options to their current platforms. After all such lenders already offer small business loans that are fulfilled by multiple investors and so EC isn’t as far of a stretch as it might sound.
The Bottom Line
Back when President Obama signed the JOBS Act in 2012, he called it “a potential game changer” for small business funding, adding, “Laws that are nearly eight decades old make it impossible for others to invest. But a lot has changed in 80 years, and it’s time our laws did as well.” With the Title III rules set to take effect early next year, it’s finally time to see how equity crowdfunding changes the way entrepreneurs start and grow their businesses. It will also be interesting to see which FinTech companies will take advantage of these new opportunities and incorporate equity crowdfunding into their operations.