Allowing everyday Americans to invest in startups has long been the dream of advocates of so-called equity crowdfunding. Title III of the Jumpstart Our Business Startups Act, which became law in April 2012, is finally codified as rules written by the SEC. As of May 16, the floodgates of equity crowdfunding will be open. Imagine if all the people who backed the Oculus Rift VR headset-which raised $2.5 million on crowdfunding site Kickstarter in 2012 and was sold to Facebook for $2 billion in 2014-had gotten a piece of the company, instead of just early access to its headsets.
But, if you talk to people building startups around equity crowdfunding, you will discover an open secret: As a mechanism for funding startups like Oculus, it is basically a nonstarter.
This is apparently deliberate. The SEC, responsible for creating the rules designed to fulfill Congress’s mandate in Title III of the JOBS Act, included rules-known collectively as the 12g rule-that are a powerful disincentive for high-growth startups to use what the SEC calls ‘regulated crowdfunding.’
These rules stipulate that any company that takes on more than 500 individual investors or grows to a size greater than $25 million in assets must start filing regular disclosures just like a publicly traded company. It is all the pain of an IPO without the benefits of the IPO.
‘When you say the SEC was putting in things to make sure equity crowdfunding isn’t used for high-growth startups, it is these rules that are the killer,’ says Kevin Laws, COO of AngelList, a portal that currently allows only accredited investors to link up and invest in early-stage startups.
These new rules also limit the amount that any individual can invest. If you have less than $100,000 in annual income or net worth, each year you can only put $2,000 or 5 percent of your net worth or income, whichever is less, into crowdfunded startups.
‘Given the disclosures that are required, I doubt a lot of tech companies are going to want to use regulation crowdfunding,’ says Erin Glenn, head of Quire, one of the startups that hopes to enable businesses to raise money thru regulation crowdfunding. Instead, says her, she sees small and local businesses using equity crowdfunding and peer to peer lending, which is also enabled by Title III, to gather funds that in times past might have come from a community bank.
Some are still determined to bend the SEC rules into a shape that will allow them to be used for tech startups. One such portal is Wefunder. ‘There’s the intent of Congress vs. what the SEC wrote,’ says Nicholas, founder of Wefunder. He is confident he has found a workaround that means all kinds of startups, including tech startups, will be launding on Wefunder soon after the May 16 date on which the SEC rules go into effect. One way to get around this is a BD can hold all the securities in street name, which counts as one shareholder of record for purposed of the exchange act.
If he is right, or if subsequent legislation from Congress clarifies or expands crowdfunding, it is possilbe at some point we will still arrive at the original vision of equity crowdfunding, which is giving everydy people access to high risk, high reward assets.
The problem with that attitude is that the idea that a nonaccredited or even accredited investor is going to somehow be successful at early stage venture capital strikes me as challenging. The worry, voiced by many, is that startups using equity crowdfunding will consist mostly of lower quality companies that could not get funding by other means. It is also true that, while it might not be appropriate for most high growth tech startups, equity crowdfunding will almost certainly be huge for some startups as a way to demonstrate market interest to traditional investors.
The next Oculus might not launch on an equity crowdfunding platform, but it might offer some shares in the company to stoke interest. Given the number of restrictions put on equity crowdfunding, though, it seems as if old fashioned crowdfunding is the most likely place for early stage companies to find that kind of support.
The current regulations seem almost draconian in the cautiousness. If you are worried equity crowdfunding could yield the 21st century version of penny stock pump and dump schemes, that is a good thing. But if you think that attitude is patronizing, there is always the chance that the SEC’s rules might someday be judged by Congress to be contrary to the original intent of the JOBS Act.