You can crowdfund your small business or new product by pre-selling on Kickstarter and other sites, but at the moment you can’t raise equity using crowdfunding, at least not in the U.S. This is about to change.
At them moment, you need to be rich to qualify to fund a startup or small business via equity crowdfunding. That keeps the masses out of the game. It means fewer ventures being funded by fewer people–result: bad for nearly everyone!
Meanwhile equity crowd funding is raising hundreds of millions in the U.K., with sites like SyndicateRoom alone raising over $50 million USD. Why are American regulators risking falling behind the rest of the world in supporting their entrepreneurs? Perhaps Wallstreet doesn’t want this big idea to eat into their lucrative IPO market! Nonetheless, it appears the tide has turned and Americans will have access to this innovative form of funding too. Expect a flurry of small business and startup creation once sites like Kickstarter get on board with this change.
History Has Been Made
It finally happened:
After three years of politics as usual, the U.S. Securities & Exchange Commission just enacted the last remaining piece of The JOBS Act.
The JOBS Act is a set of laws that opens up the private equity markets to all U.S. citizens. Historically, only “accredited investors” (those who earn at least $200k per year, or have a net worth of at least $1 million) were allowed to invest in private equity deals such as start-ups.
But now, because of the enactment of Title III of The JOBS Act, all investors, regardless of income or net worth, can enter this market.
For investors, this is reason to celebrate. Historically, this “off-limits” market has been delivering the highest returns. In fact, prior to Title III being enacted, CNBC called private equity “The best retirement asset you can’t have.” According to the article, “Time and again private equity has proven that it’s the single-best asset class for public pensions, by delivering superior returns over longtime horizons.”
Let’s re-cap how we got here.
The History of The JOBS Act
There were two main inspirations for the creation of The JOBS Act:
Job Growth — Historically, most new jobs in this country have been created by small businesses. By making it easier for small businesses to raise capital, the government hoped that more businesses would get started—and more new jobs would be created.
Crowdfunding — Over the past several years, an online trend called crowdfunding has emerged. On websites like Kickstarter and Indiegogo, entrepreneurs solicit “donations” for their projects (e.g., a new toy, video game or film). Those who donate might receive a free version of the product when it ships, or an exclusive screening of a new film. This concept is known as “rewards crowdfunding,” because contributors receive a reward for their financial support.
The downside here is that, if these projects go on to become billion-dollar enterprises, the initial backers won’t receive any of the upside. Not a penny.
Title III of The JOBS Act aims to remedy this with a concept known as “equity crowdfunding.”
With equity crowdfunding, financial contributors receive equity—i.e., an actual ownership stake in the businesses they back. So if a business becomes the next Oculus (or Microsoft or Google), early backers will receive their share of the gains.
But in order to make this happen, 83 years of securities laws had to be rolled back. Ever since The Great Depression, everyday citizens have been legally prohibited from investing in privately-held securities.
With the passage of the JOBS Act, all that is now changing.
Although the JOBS Act was passed in 2012, the SEC didn’t enact it all at once.
One of the first components it did enact was “Title II.” This piece of the law—which applies only to Accredited investors—allows start-ups to advertise that they’re raising capital, and to post their investment deals online.
Deals are hosted on websites known as “Funding Platforms.” These platforms play matchmaker between entrepreneurs seeking capital and investors looking to invest.
What’s driving all this demand for private market investments?
Recent headlines about highflying start-ups from mainstream press like The Wall Street Journal are helping drive demand, for example:
Airbnb Raises $1.5 Billion in One of Largest Private Placements
Alibaba Deal Values Snapchat at $15 Billion
Uber Valued at More Than $50 Billion
Coincidentally, Uber isn’t just one of the faster growing start-ups in the world today—it’s also one of the first major crowdfunding success stories:
In 2010, Uber leveraged a website called AngelList (which is now one of the largest equity crowdfunding platforms) to raise its initial round of funding.
If you’d been a member of AngelList, and had been accredited at the time, you could have become an angel investor in Uber when it was still “cheap.”
But will the new regulations do enough to protect investors?
Well, during the vote to approve Title III, the SEC commissioners cited “investor protection” as a high priority more than a dozen times…
And the final rules do contain certain protections—for example, someone making less than $100,000 per year can only invest 5% of their income into Title III deals (so if they earn $50,000 per year, they can invest $2,500).
But if someone jumps into this market without knowing what they’re doing, the SEC’s protections can do little more than limit an investor’s losses.
You see, despite the high historical returns provided by early-stage companies, start-ups are an inherently high-risk investment. In fact, most fail.
If you look at the portfolios of most venture capital funds—The vast majority of their investments lose money; a small portion break even; and ultimately, just a small handful of deals provide the vast majority of the returns.
If an investor takes the $2,500 “chip” the SEC allots them, and they bet it all on a single start-up, odds are, they’re going to lose the whole thing.
To protect themselves, they need to understand start-up investing basics—for example, how to build a portfolio of start-ups, and how to weed out the riskiest companies.
By educating and empowering individual investors, we believe we can help them avoid making costly mistakes—and provide them the highest chances for success.
Read full original article on CrowdAbility.