Spend a little time in the startup world and you’ll quickly become familiar with crowdfunding, from consumer platforms like Kickstarter or Indigogo to the new equity crowdfunding models. Launching a crowdfunding campaign is becoming a great way for startups to gain exposure while generating financial support for their project – and in the same time, validating it.
So how does it work? Supporters that contribute funds for a startup’s cause, known as “backers,” generally receive an item in return, whether a token of the startup’s appreciation or an early version of the product.
For a famous example, consider the Oculus Rift. In 2012, Oculus Rift ran a KickStarter campaignthat raised $2.4 million. Contributors received everything from T-shirts to a prototype kit. Just four years later, Oculus Rift was acquired by Facebook for $2 billion. If this was an equity situation, investors would have received a 145x return. And that’s where equity crowdfunding comes in.
New Rules for a New Market
Over 3 years ago, the U.S. Security and Exchange Commission (SEC) compiled the JOBS Act laying the foundation for investment opportunities in the 21st century. Title III of this bill had language geared towards equity crowdfunding but lacked clarity until this July.
Of course, hundreds of pages of legal jargon isn’t something either of us would enjoy poring through – so let’s check out some of the most exciting provisions of this bill.
Startups Can Raise $1 Million/Year – With One Loophole
“Only $1 million?! Really?!”
If you were one of the individuals hoping that the SEC would increase the maximum higher than $1 million, Title III won’t impress you.
However, Title IV (Regulation A+) of the JOBS Act mentions that startups have the opportunity to raise up to $50 million by holding a mini Initial Public Offering (IPO) for their campaign.
Accredited Investor? No Need
Over the past few years, who can take part in equity crowdfunding has been wildly debated.
At first, if you weren’t an accredited investor – meaning someone pulling in at least $200,000 per year and holding a net worth of at least $1 million – you were not eligible to contribute towards an equity crowdfunding campaign. These stakes would put you in the top 3% of America – which greatly limited investee access.
The JOBS Act eliminates this criteria so now anyone can contribute regardless of their annual income. Limits remain to how much a backer can contribute.
Limitations of the Crowd
The SEC actually tightened the limits on contributors investing in a startup.
According to the codes, investors are limited to:
(a) the greater of $2,000 or 5 percent of the lesser of their annual income or net worth, if either the annual income or the net worth of the investor is less than $100,000
(b) 10 percent of the lesser of their annual income or net worth, if both the annual income and net worth of the investor is equal to or more than $100,000.”
In other words, the ceiling stops at $100k for individual investment.
Equity Crowdfunding is Affordable for Startups
A major concern in a past proposal was the requirement of a full financial audit on a startup before launching a campaign. Costing over $10,000, these funds would be taken out of much more important business expenses.
Luckily, the SEC agreed this proposed requirement was excessive and unrealistic for most emerging startups. They struck down this provision, replacing it with a reasonable alternative.
If a startup using equity crowdfunding wants to raise more than $100,000 financial review records are required – but not below this threshold.
Big Crowdfund, Big Responsibilities
With great opportunity comes great responsibility.
Startups have to disclose all of the campaign’s information from start to finish. This includes security values, the target amount, target deadline, and other important variables.
The SEC needs to stay in the loop at all times, which demands lots of logistical information, business descriptions, employee profiles and other homework for entrepreneurs.
Most importantly, equity crowdfunding is the sale of securities and these laws vary by region.You want to assure that you have met all of the state and federal requirements for the sale of securities. If not, it is possible to be charged for violating a required financial mandate. And believe me, that’s no fun. Your best bet is to educate yourself and your team on what’s required on a state and federal level to avoid any complications.
The Rising Tide of Crowdfunding
The JOBs act has become law as of May 2016. I expect to see a surge of crowd funding platforms to emerge in the near future. Indiegogo has announced that they will develop an equity crowdfunding service, in fact. For startups, equity crowdfunding will be another great resource to raise funds.
