Unleash the power of the crowd? Not so fast. Though new rules promulgated by the Securities and Exchange Commission to empower equity crowdfunding are generating a lot of excitement, followers and participants say the actual reaction has been more a measured approach and less an opening of the floodgates.
“Long-term, absolutely we’ll see the power of the crowd come through. I think the reality is that regular people aren’t stupid. They’re not throwing thousands of dollars at these wild lottery tickets they don’t fully understand, like some of the more conservative investor types might assume,” said Michael Norman, president and co-founder of the crowdfunding portal WeFunder.
Still, Norman said that in the past two weeks since the SEC’s new rules permitting equity crowdfunding for unaccredited investors took effect, WeFunder has experienced an uptick in traffic by both investors and entrepreneurs. The crowdfunding portal now has around 21 companies and 60,000 investors, he estimated, and most of those newer investors are committing sums under $500 apiece.
To understand why equity crowdfunding is a big deal, let’s zoom out to the big picture for a moment. Under the Securities Act of 1933, anybody who wants to offer and sell a security has to either register with the SEC or find an exemption from doing so. The most common form of exemption is a so-called private placement.
Registering with the SEC can be an expensive and involved process, said Jeffrey A. Clopeck, a corporate partner with Day Pitney in Boston, so what most companies would do to avoid that process is offer a private placement. Until now, under the most common form of private placement, all purchasers would have to be accredited investors, meaning that they had annual income in excess of $200,000 (or joint income with a spouse in excess of $300,000) or net assets greater than $1 million.
“It was possible to sell to non-accredited investors before equity crowdfunding, but you had to have a more robust disclosure,” he said. “It was burdensome and not cost-effective.”
It was the Jumpstart Our Business Startups (JOBS) Act of 2012 that changed that with a provision known as Title III that added a new exemption for equity crowdfunding transactions. The SEC set to work writing the rules and now, four short years later, equity crowdfunding has been made available to the masses.
Of course, there are limitations imposed on both ends. Issuers can raise up to just $1 million per 12 month period, and investors with an annual income or net worth of less than $100,000 are limited to the greater of either $2,000 or 5 percent of either their net worth or annual income, whichever is lesser. Investors can participate in equity crowdfunding through either a broker-dealer or a crowdfunding portal, which must register with the SEC. According to the agency’s website, 11 crowdfunding portals have so far registered with the SEC.
“The first wave of people who are going to take advantage of this are people who are nearly the accredited investor but not quite. That’s what makes the most sense. They come close, but they are prohibited from so much,” said Denise Valentine, a senior analyst at Aite Group whose research has focused on crowdfunding.
She draws a parallel with the mutual fund industry, which struggled mightily to get your average Joe to feel comfortable investing in mutual funds.
“There’s lots of folks who are near that threshold [to become accredited investors],” she said. “I don’t think your average man on the street is going to be doing this.”
Whiskey, Doughnuts & Bionic Body Parts
Don’t expect to see the next Uber or Facebook raising cash through equity crowdfunding, Clopeck said. The $1 million limit per 12-month period pretty much restricts this vehicle to smaller businesses.
Meanwhile, Valentine names real estate as one area that could particularly benefit from equity crowdfunding, with portals like Patch of Land and Fundrise already operating in that space, and consumer goods that the average person can easily understand.
“It’s much more tangible,” she said. “The investment is a little easier to make because you have a feeling like, ‘OK, I understand that business.’”
Scroll through WeFunder and you’ll find a whiskey distillery, a gourmet doughnut shop and a biotech firm working on a bionic pancreas for people with Type 1 diabetes.
Crowdfunding portals themselves have to meet certain obligations and register with both the SEC and FINRA, and Norman said that a few tweaks to the rule could benefit both investors and entrepreneurs – for instance, letting up on the requirement that companies adhere to generally accepted accounting principles, which he says is rare to see at the startup level.
But beyond the risks and potential returns, Norman also highlights a less tangible reason that people might choose to participate in equity crowdfunding.
“I think it’s important to understand the psychology that people are coming into this with: I want to be able to invest in things that are important that I want to see exist,” Norman said. “The profit motivation is almost a secondary motivation at this point.”
