Up until now, entrepreneurs raising money through crowdfunding platforms such as Kickstarter promised their backers products in exchange for funding.
But last week the Securities and Exchange Commission approved a law allowing the general public to participate in equity crowdfunding campaigns.
The new rules will allow small investors to buy shares of private companies under the provisions of the Jump-Start Our Business Start-Ups (JOBS) Act. Prior to this change, equity crowdfunding had been legal only for accredited investors - those with high incomes or a high net worth.
According to a Forbes article, equity crowdfunding was already set to surpass traditional VC funding in 2016 and the new rules will more or less guarantee this. Key quote:
Crowdfunding was already expected to surpass VC funding in 2016 at $34B a year in total crowdfunding online, across all types of crowdfunding. By bringing in a new class of investors with Title III, we can expect further growth of the equity market as venture capital continues to move online.
The new rules around equity crowdfunding are quite complex, as is pointed out by this Venture Beat story. At 685 pages long, most small businesses will need legal help to make sure they are following the rules. Key article quote on compliance:
If you fail to comply with the rules (like submitting your annual report with the SEC within 120 days after the end of your fiscal year and posting a link on your website), you could lose your exemption, which means that you will face hefty fines and legal fees to defend yourself. Be sure to follow all the rules/filings before, during, and after you raise your funds. For instance, you cannot list your offering on more than one platform. Also if you want to host a launch party to promote your offering, do NOT do so with the funding portal (unless it is a broker-dealer) because that is considered offering investment advice (by the funding portal), which is not allowed.
Not everyone thinks this is a good idea. Key quote on the potential downsides from a New York Times article:
The equity shares they buy will be risky, illiquid investments. Investors will generally be required to hold on to the shares for at least one year, and there are not yet many marketplaces for those seeking to sell shares in private companies, which are difficult to value.
Some critics are deeply skeptical about the quality of the investments that will be available. “Ninety-nine percent of these deals will prove to be unprofitable,” said Andrew Stoltmann, a lawyer who specializes in securities fraud. “This is a disaster waiting to happen.”
As a long time angel investor I have mixed feelings about this bill.
It will clearly make it easier for startups and small businesses to raise money - especially from friends and family and others who would like to invest but are not accredited investors.
But I've dealt with a whole lot of disgruntled angel investors over the years who, frankly, didn't understand the risks they were taking even though they were supposed to be sophisticated investors. I suspect opening up equity crowdfunding is going to result in many unhappy investors.
I also think there will be more fraud than is anticipated.
But hopefully the positives will outweigh the negatives.