Crowdfunding Startups: Investing for the Masses

The digital age has lead to a boom in the practice known as “crowdfunding” This alternative form of finance has become increasingly popular thanks to websites like GoFundMe and Kickstarter where everyone from inventors to filmmakers to those seeking charitable donations can go to get their project funded through small contributions from large numbers of people.

Securities laws previously prohibited allow non-accredited investors investors to buy stock in a company through crowdfunding—that is, until now.

At the end of October, 2015, the SEC adopted final rules to implement the crowdfunding sections of the Jumpstart Our Business Startups (JOBS) Act from 2012.  As a result, the door will soon open for securities crowdfunding to all types of investors. This means that startups will be able to sell stock in their company through the process of crowdfunding, and main street investors will be able to get in on the action at the ground floor and potentially profit if when he/she encounters the next new and exciting startup idea, rather than having to wait for the company’s IPO.

Startups were previously much more limited in their ability to obtain financing for their company, being forced to rely on wealthy venture capitalists, angel investors, or pricey loans. The new SEC rules open the door for startups to seek out financing from the masses—average joes who like their idea and want to be a part of creating the company.

Many people (including the SEC and myself) are weary of the potential for fraud and for inexperienced investors to be taken advantage of.  As a result, I expect that the SEC will keep a close eye on the practice and the companies using this methodology.

One of the ways in which the SEC hopes to mitigate the potential for fraud is by requiring that all crowdfunding securities offerings be conducted through a brokerage firm or special online portals that are registered with the SEC. Such portals will be required to conduct some levels of diligence on the startups and inform potential investors of their rights and obligations.

While the most frequently used private offering securities rules limited startup investing to “accredited investors” (i.e., those parties with net worths of at least $1 million (excluding their home) or who had made a minimum of $200,000 in income for two consecutive years), now people with an annual income or net worth less than $100,000 can invest up to 5% of their income or net worth, or $2,000—whichever is greater. Those with incomes and net worths higher than $100,000 will be able to invest up to 10%, though main street investors will not be able to invest more than $100,000 towards securities crowdfunding in any 12 month period.  Of course, investors at these levels of income should discuss any such investments with their financial advisors, as these sorts of investments tend to be the riskiest and most illiquid investments around.  

Under the crowdfunding rules, Startups will be limited to $1 million raised per year from crowdfunding sources without having to register with the SEC.

The new SEC rules will take effect in mid-2016, so startups and main street investors will have to wait before they can jump into the securities crowdfunding game. However, soon investing in startups will be open to the masses, and young, innovative companies will have much more potential to obtain the financing they need to thrive.

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