FEB 03, 2015 13:24 PM
Industry Waits for New Crowdfunding Rules
Provisions would open up startup funding to a wider audience
By Margo McCall
When the US JOBS Act was passed in April 2012 with overwhelming bipartisan support, it was heralded as a historic victory. No longer would Wall Street have exclusive control of startup fundraising. Instead, startups would be able to reach out to regular people as investors. But two years later, the US Securities and Exchange Commission (SEC) has yet to finalize rules on two of the act's key provisions.
If you’ve been waiting for crowdfunding to take off in order to start your new tech company, it looks like you’ll have to wait a little longer.
Title III of the US JOBS Act would let startups raise up to $1 million from unaccredited investors, and Title IV would let startups raise up to $50 million through solicitations. The SEC initially expected that rules for both would be approved by the end of last year. But in December, the commission pushed that back to October 2015, with the rules taking effect in early 2016.
Crowdfunding industry on hold
Meanwhile, an entire industry of crowdfunding platforms, financial advisors, law firms, consultants, trade associations--and capital-hungry startups and their founders--wait in virtual limbo for the promise of fundraising democratization to take hold.
"The regulators don’t know yet how to manage it and control it. There is a fear of the unknown," says RocketHub CEO Brian Meese, a speaker at Startup Rock Stars, March 24 in San Francisco. "It’s a very tricky thing to get right. We’d rather the regulations be right than fast."
The JOBS Act--short for Jumpstart Our Business Startups--was intended to help alleviate the funding gap and regulatory concerns faced by startups and small businesses in connection with raising relatively small amounts of capital.
Leonhardt Ventures Executive Chairman Howard Leonhardt, another Startup Rock Stars speaker, lobbied for passage of the JOBS Act as Startup California's state spokesperson. He has given more than 40 speeches on the subject.
Leonhardt says he became interested in financial reform after receiving $4.3 million in bills from underwriters, commissions, and road show costs from his biotech company Bioheart's February 2008 initial public offering. That was more than twice what the IPO netted.
Protecting future investors
SEC Chair Mary Jo White noted that the intent of the JOBS Act was to make it easier for startups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors. But she added that, “We want this market to thrive in a safe manner for investors.”
The proposed rules would let companies raise up to $1 million per year through crowdfunding offerings. Individuals could invest up to $100,000 in crowdfunding offerings, but would have to hold onto their investments for at least a year.
In addition, companies would have to disclose information about their officers and owners and supply financial reports. And companies outside the US, that are already reporting to the SEC, or that have no business plan, would be ineligible.
To protect investors, Title III requires that broker-dealers and funding portals be registered with the SEC, provide investors with educational materials, and take measures to reduce the risk of fraud. The portals would be prohibited from handling funds or offering investment advice.
The goal of Title III was to give startups a less expensive way to raise money. But as a New York Times article noted, complying with the SEC regulations would cost about $6,500 for the offering, $4,000 for each annual report, and $28,700 per year if the company has to submit audited financials. The funding intermediary will also charge an estimated commission of 5-15 percent.
Reward vs. equity crowdfunding
"The jury's still out on what will happen with the JOBS Act," says Meese. "We’ll have to wait a while to see ultimately what happens."
Title II of the JOBS Act, which became law in September 2013, allowed private companies to solicit investment and use reward and donation crowdfunding sites such as Kickstarter and Indiegogo to raise money—which was in itself a major victory for crowdfunding.
Globally, reward and donation crowdfunding raised more than $5 billion in 2013. Reward crowdfunding is used to raise small amounts of money from large numbers of people for everything from disaster relief, charities, and artists' projects to new software and high-tech products. Increasingly, it's viewed as a way to test interest in new products and projects and generate awareness before getting larger investors involved.
Those who donate can receive benefits such as meetings with company founders or product samples, but they can't receive any shares in the company. Currently, an offer or sale of securities must be registered with the SEC unless an exemption such as Title III is available.
As the National Crowdfunding Association describes it, most entrepreneurs start their business by maxing out credit cards then getting “friends and family” financing, before moving on to “angel” financing from a wealthy individual, bank loans, and money from venture capitalists. Crowdfunding expands the “friends and family” stage, according to the association, and it’s often a step on the path to getting angel and VC investors.
Margo McCall is Editorial Content Manager for the Computing Now destination site. Have an idea for an article or wish to contribute? Email Margo at firstname.lastname@example.org.
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