Equity crowdfunding is a type of crowd sourcing where the investor receives ownership or equity in the company in exchange for their investment. It is different from the traditional donation-based crowdfunding sites such as Kickstarter, where backers receive a product or service gift from the company for their donation.
Because the rules associated with the JOBS Act 2012 have not been finalized, using equity crowdfunding to raise seed money from the general public is still not allowed. Currently, only accredited investors can participate in equity crowdfunding. An example of a crowdfunding portal that is raising equity capital from accredited investors is Crowdfunder.com. For a person to qualify as an accredited investor, they have to have a net worth, or joint net worth with their spouse, that exceeds $1 million at the time of the purchase. It is important to note that the calculation of net worth used to qualify an accredited investor cannot include the investor’s equity in their primary residence. Another way a person can qualify as an accredited investor is by having an income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years. This investor must also have a reasonable expectation of the same income level in the current year.
In the near future, non-accredited investors will also be able to invest in equity crowdfunding campaigns. Non-accredited investors will have to wait for the adoption of implementing rules associated with the JOBS Act 2012. The section of this law that will permit non-accredited investor participation in crowdfunding equity financing is called the JOBS Act III. Title III is expected to go before Congress and to be passed in mid-2014.
The SEC has already published a number of proposed rules regarding the regulation of equity crowdfunding that is offered to non-accredited investors. They are currently receiving comments before they are finalized. One rule limits the amount a non-accredited investor can invest in any 12-month period. What the SEC is currently suggesting is that if a person’s annual income or net worth is less than $100,000, they will be allowed to invest the greater of $2,000 or 5 percent of their annual income, or net worth, into crowdfunding offerings per year. If their income is over $100,000, they will be allowed to invest 10% of their annual income, or net worth, up to a maximum of $100,000, in crowdfunding offerings per year. As a side note, the SEC is proposing that when a person calculates their net worth, they can’t count the value of their primary residence.
There are a number of rules being proposed by the SEC which might cause equity crowdfunding to be dead on arrival. One such rule will limit the amount of financing you can raise using equity financing to $1 million dollars. Another unpopular rule that might kill equity crowdfunding are the onerous disclosure requirements. For example, companies that intend to raise capital using equity crowdfunding will be required to have background checks done on all principles with 10% or greater ownership in the company. A business plan, audited financial statements and a full description of the company’s ownership and capital structure will also be required. Financial statements must be audited if a company plans to raise more than $100,000.
Many entrepreneurs have already informed the SEC that the disclosure requirements, as they stand, will discourage startups from using equity crowdfunding. They have told the SEC that these companies are already operating on a shoe-string budget and can’t afford it. Furthermore, requiring audited financial statements from companies that don’t have anything to speak of doesn’t make sense.
The rule being proposed by the SEC that will be probably be the biggest buzz-saw to equity crowdfunding is the rule that will prohibit companies doing equity crowdfunding from directly communicating with potential investors. Most successful crowdfunding campaigns owe their success to massive social network marketing campaigns. Most equity crowdfunding campaigns will likely fail in reaching their funding goal if this rule is implemented.
It also appears that the proposed SEC rules will also discourage many companies from offering equity crowdfunding. What the SEC is proposing is that companies that are equity crowdfunding portals will either have to be a broker registered with the SEC or become members of a national securities association that is registered under Section 15A of the Exchange Act. Today, FINRA is the only national securities association in existence that is registered under Section 15A of the Exchange Act. The SEC estimates that it will cost crowd sourcing sites an average of $10,000 to become a member of FINRA. They also estimate that each crowdfunding site will be burdened with approximately 1,500 hours of labor and it will cost $250,000 – $600,000 to build an Internet-based crowdfunding portal that is compliant with the new law.
The other thing that will discourage many crowd sourcing sites from providing equity crowdfunding is the potential for liability. The rules, as currently written, will hold crowdfunding portals liable for material misstatements made by companies raising capital on their website. This requirement will require crowdfunding sites to do an exhaustive vetting of every equity crowdfunding campaign they put on their site. This rule alone will probably discourage most crowdfunding sites from providing equity crowdfunding.
Many entrepreneurs are wondering if these new rules will impact traditional crowd sourcing. Since traditional crowdfunding doesn’t involve selling of securities, It won’t fall under the jurisdiction of the SEC. As a result, traditional crowd sourcing campaigns will not have a limit on the amount of money they can raise. They will also not be burdened with the complicated and expensive disclosure documents that are required with equity crowdfunding. The biggest advantage of traditional crowd sourcing is that it will continue to allow direct marketing to potential investors.
So should you use equity crowdfunding to raise business capital? Unfortunately, for many companies, the answer will be no. The SEC rules that are being proposed for equity crowdfunding make it too expensive and impair the ability to mount an effective crowdfunding campaign. Fortunately, these rules will not be applied to traditional crowd sourcing. Because of this, traditional crowdfunding will be the better option to raise business capital hands down.
If you are interested in raising business capital using traditional crowd sourcing, I would recommend that you check out NewBizCrowdFunding.com. NewBizCrowdfunding.com has many of the same features as crowdfunding sites, such as KickStarter, with fees that are some of the lowest in the industry.
Crowd sourcing is not an appropriate source of funding for many businesses. For most small to medium businesses, the best source of financing is an SBA loan. If you are seeking an SBA loan, I would recommend using the leading nonbank provider of SBA funding, Newtek, the “Small Business Authority.” To start your application, go to FundingNewBusiness.com. In most cases, you can be pre-qualified in as little as 48 hours. The application process is easy. Newtek completes all of the SBA application documents for you. Get access to funding for as much as five million or as little as fifty thousand dollars today!
Written by: Mark J. Krupp, Cofounder of NewBusinessCreator.com