The U.S. Securities and Exchange Commission (SEC) finalized last week the rules guiding how startups can sell equity. What are the details and what is next after these new guidelines become active on Jan. 29, 2016?
While the 2012 Jumpstart Our Businesses Act (JOBS) Act opened the doors for the public at-large to invest part of their income in tech startups, since then the nation has had to wait patiently for the SEC to define and approve the rules setting limitations on who could invest and how much. After healthy debate, the SEC has removed the provision that new businesses can only sell equity to “accredited investors” – individuals worth $1 million or earning more than $200,000 a year.
The new rules on crowdfunding allow anyone with a net worth less than $100,000 to invest up to $2,000 (or 5 percent of their net worth, whichever is greater) over a 12-month period. If an investor has an income and net worth greater than $100,000, they can invest up to 10 percent of their net worth. The new rules will be effective Jan. 29, 2016.
To date, willing crowdfunding investors have been lured as startup backers merely by the possibility of receiving a token item in return – such as a sample of the innovative product, or even just a T-shirt (think Indiegogo or Kickstarter campaigns seen until now). Now, the chance for equity ownership expands the pool of potential investors in startup innovations to greater numbers, new geographies and from a variety of backgrounds.
Soon after the SEC issued the new rules, the largest European crowdfunding company, Seedrs, announced that it will start a beta test of its platform in the U.S., with plans for a full launch in early 2016. By enabling all types of investors to purchase shares in small, growing companies, Seedrs claims to have funded more than 270 companies to date, and has raised an average of 5.38 million per month. Companies like Seedrs have been waiting for the U.S. to join the ranks of countries that have legalized and expanded equity crowdfunding, such as the United Kingdom. They are ready to abide by SEC rules mandating platform companies educate consumers about the process and risks involved in investing.
While angels invest higher sums compared to individuals through crowdfunding campaigns – angels typically invest between $250,000 to $500,000, in exchange for equity – crowdfunding is a type of financing that comes with its own advantages for business owners. First, crowdfunding comes with a built-in, wide customer base that can provide feedback and publicity – which is important in an era when founder teams build companies like one would build an airplane in the air. Second, crowdfunding provides the entrepreneur with freedom from depending on close-knit investment “know-who” circles that have traditionally closed gates to outsiders or newcomers.
Equity crowdfunding will not be restriction-free, of course. During a 12-month period, a startup can only offer a maximum aggregate amount of $1 million. That any business looking to raise over that amount will need to explore traditional avenues for financing is not a negative factor. With a rapidly expanding number of angel investor organizations ready to take the baton, and increased awareness regarding the need of startups to focus more on product development and validation, the $1 million limit will appropriately discipline less capital intensive new firms that need to be able to afford to fail fast if necessary.
As governments roll out more regulatory changes aimed at better enabling new firm formation, the challenge now turns to whether they have prepared adequately to measure the impact of their efforts. This will be a focus for the upcoming Startup Nations Summit for policymakers in Mexico Nov. 21 – 22 this year. A new initiative called the Startup Nations Atlas of Policies (SNAP) will be announced, which documents such efforts and sheds light on whether governments are measuring effectiveness.
This should now be where the debate turns to crowdfunding in the United States. Ahead of Jan. 29, 2016, startup communities, founders and government agencies should not just be aware of what to measure in terms of efforts to open up crowdfunding, but also to assume a shared responsibility for collecting and analyzing data. Was it lenient enough? Was the process made sufficiently user-friendly to be worthwhile for startups, or does it remain too cumbersome? Are we measuring this right?
The new equity crowdfunding regulations from the SEC are a real step forward for the U.S., after several years of deadlock while other nations rapidly moved ahead. Let’s hope the government’s cautious approach results in an equally rigorous outcome assessment both in terms of increased engagement by American citizens in their fellow risk taking entrepreneurs, and proper protection of our least experienced – even if enthusiastic – consumers. I hope you will comment on this and help crowd source how we do this.
Photo Credit: Flickr
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