Want to invest in the next Google or Apple while it’s still on the ground floor? Equity crowdfunding allows you to do just that. Thanks to the recent passage of the JOBS (Jumpstart Our Business Startups) Act, non-accredited investors* can now invest in private companies, something that the SEC has prohibited since the passage of the Securities Act of 1933. In exchange for this investment, the company offers equity to the investor in the form of stocks, bonds or “revenue bonds” (i.e., bonds that pay a certain percentage each year).
Invest in the next big thing
Crowdfunding as a concept has been around since at least 1997, when the British rock group Marillion raised $60,000 through its fan base to cover the costs of a North American tour. Currently, the best-known crowdfunding website is KickStarter, which helps raise funds for various projects ranging from charity balls to films. Kickstarter’s biggest success was Pebble Technology Corporation, a start-up that promised a smart watch in exchange for a $115 donation. By the end of its crowdfunding term, Pebble had collected a grand total of $10.27 million from 68,929 investors. Time will tell if the company can now deliver on its promise of 85,000 smart watches to crowdfunding backers.
Kickstarter’s crowdfunding goals have been successful; however, investors can only donate money in exchange for a nominal reward like a T-shirt or a watch. In other words, investors can’t gain access to the company itself and share in its (eventual) revenues. With the passage of the JOBS Act, those rules have changed. Through equity crowdfunding sites such as WeFunder and CrowdFunder, ordinary folks like you and me will be able to actually invest in start-ups much like venture capitalists or banks. This means that, should the companies become successful, we’ll have a stake in their success and the accompanying (monetary and other) rewards.
Before you start throwing your cash at a private businesses, however, keep in mind that equity crowdfunding is still illegal under federal securities laws. The SEC has stated that, until it publishes its own rules and regulations regarding how equity crowdfunding is performed, the practice will not be allowed. Suggested guidelines (and probable future rules) from the SEC are already in place, many of which can be found on the SEC’s JOBS FAQs about Crowdfunding. The SEC is expected to officially release its rules by early 2013.
Become the next big thing- with a little help
On the flipside, what if you’re looking to raise money for your big idea or to hire much-needed employees or purchase equipment? Equity crowdfunding allows you to raise up to $1 million by offering private investors a stake in your business. However, as stated before, there will be some SEC rules governing what your business can and can’t do. Here are some rules that the SEC will likely be releasing based on its current guidelines:
- Incorporate your business (e.g., become an LLC).
- Create a business plan. The U.S. Small Business Administration provides you with a free business plan template.
- If you have earned any income from your business, create an earnings statement.
- Write biographies for all of your business partners.
- Describe what the funds will be used for and when/where they will be spent.
For big sums of money, the SEC will no doubt require the following:
- For $100,000 or more, have a public accountant look over your offer.
- For $500,000 or more, create a financial statement and have it audited.
More than likely, you will not be raising your funds alone but through crowdfunding intermediaries like WeFunder and CrowdFunder. The SEC is going to have some rules for intermediaries too, including:
- Intermediaries must register as brokers/dealers with the SEC and FINRA (Financial Industry Regulatory Authority).
- Intermediaries must act as objective third parties between the investor and the crowdfunding companies. As a result, intermediary employees cannot be compensated for recommending a given company to an investor. Intermediaries also cannot hold or manage investor funds/securities.
If you are unsure about any of these processes or would simply like to CYA (cover your ass!), it never hurts to enlist the services of a corporate lawyer.
Equity crowdfunding criticisms
Critics of the JOBS Act point to the possibility that scam artists will swindle uninformed investors out of their money by offering stakes in bogus companies. The Securities Act of 1933 was put in place precisely because many small time investors had invested their life savings in businesses that did not disclose all risks- and then went bankrupt. However, at least according to the limited crowdfunding efforts (e.g., Prosper.com) that have already been underway, funding intermediaries have been largely successful at blocking fraud. Furthermore, SEC equity crowdfunding guidelines already limit private individual investments to no more than $10,000 or 10% of an individual’s net income or net worth, respectively.
More than likely, however, crowdfunding will go through a period of optimism and disillusionment before settling into a plateau of fruitful maturity, at least according to critic Todd Hixon. Until then, hopeful investors should work closely with funding intermediaries or even their lawyers (again, CYA) to make sure that equity-issuing companies are disclosing all the risks involved with investment. Much like with the stock market, you can end up losing your shirt.
*In case you may be wondering, the SEC defines a non-accredited investor as anyone who has made under $200K/year for the last 2 years and whose net worth is under $1 million. Thus, most regular Joes and Janes did not qualify as investors pre-JOBS Act.