On May 16, the startup world changed forever. Title III of Obama’s 2012 Jumpstart Our Businesses (JOBS) Act became effective across America. So what does this mean and why is it important for startups?
Title III, also known as Regulation Crowdfunding, was part of a series of titles implemented by the Securities and Exchange Commission (SEC) to help promote growth in emerging private U.S. companies, many of which are startups. The title’s greatest reformation is its regulation to crowdfunding. Previously, startups wanting to raise money had limited options–they could use reward-based (Kickstarter) or donation-based (GoFundMe). If neither of these options were applicable, they would have to apply for loans from banks (debt-based) or pitch to angel investors or venture capitalists (equity-based), a long and highly selective process.
Title III brings equity-based crowdfunding to a completely new level, allowing “non-accredited” investors to invest in startups. Michael Stacey, a 2011 MC finalist and founder of VG SmartGlass, believes that this crowdfunding innovation is a “whole new channel” for entrepreneurs. So what is so important about this legislation?
Depicted below is an image comparing before and after May 16. The biggest takeaway is that any stage in the funding process can now be crowdfunded using public markets.
Krishan Arora, founder of Arora Project, believes that “there are just some regulations and rules that need to be understood and followed by investors and start-ups, but as long as that is done, this should be a force for the good.” For starters, anyone can invest or receive investment as long as you meet some specific requirements, outlined in a SEC press release. Chances are you won’t read the press release, so here are some key takeaways.
Requirements (for startups)
- You must be registered as an entity in America
- Your investment cannot exceed $1 million per 12-month period
- You must use an online platform (intermediary)
- You must disclose financial information (ex. how much you plan to raise, price per share, how you plan on spending investment, tax returns, etc.)
- You must report periodically to the SEC and are subject to an accountant investigation
Requirements (for investors)
- “Non-accredited investor” defined as a person who makes below $200,000 a year and has a net worth of less than $1 million
- If your net worth or income is below $100,000, you can invest whichever is lower: $2,000 or 5% of annual income or net worth.
- If your net worth or income is between $100,000-$199,999, you can invest whichever is lower: 10% of annual income or net worth.
- A person can’t invest in securities totalling more than $100,000 in a 12-month period
Now let’s talk risk-benefit analysis.
- There is a limit to the amount of money that you can raise ($1 million in a 12-month period).
- You need to release important information about your company, sharing (and exposing) your idea to the world.
- You need to value yourselves, a lengthy and difficult procedure (as opposed to a VC firm helping you). Your valuation, without proper due diligence, may discourage others from investment.
- You need to have conversations with many investors and constantly update them.
- NOTE: Some platforms (such as WeFunder) pool all the investors into one “lead investor,” who handles the communication between the company and investors
So what are the possible benefits? Well for starters, it’s a booming industry. The World Bank estimates that crowdfunding will reach $90 billion by 2020, $36 billion of it in equity crowdfunding, thereby overtaking venture capitalists ($30 billion) and angel investors ($20 billion). Krishan believes that “the power of the new equity based crowdfunding is now allowing for start-ups to acquire more capital to help launch their businesses.” Let’s take a closer look.
- You can crowdfund with equity to the masses.
- You can raise smaller investments without giving away too much equity.
- You can promote your brand as a byproduct of asking for investment.
- You can involve the community in the growth of your company.
- You don’t have to give away voting rights or board seats.
It is great for early stage startups. Pablo Preciado, former Project Manager at MC Alum startup Flatev, believes that early stage startups, which usually don’t have the potential to scale, won’t be attractive to VC firms. Instead, they can turn to equity crowdfunding.
Although the regulation is revolutionary, critics argue that some of its rulings are not enough to help startups. Congressman McHenry has proposed the “Fix Crowdfunding Act” (HR 4855) aimed at raising the funding cap from $1M to $5M, implementing funding portals to decrease fraud, and adding special purpose vehicles (SPVs) to provide better management to cap tables.
So what should startups do? First, see if equity crowdfunding is right for you. Do some more research. If you explore and then decide yes, then try to find a reliable crowdfunding intermediary, which I’ve started researching here. And good luck!
I look forward to seeing the impact of this legislation on the startups in the coming months.