The challenge of raising money to start a business is often a tough one, but new rules just issued by the Securities and Exchange Commission could make capital-raising easier while also opening new opportunities for investors to support worthy entrepreneurs.
The SEC on Oct. 30 adopted final rules to permit companies to offer and sell securities through the popular online method called crowdfunding.
This technique for funding all sorts of projects and charitable causes by inviting supporters to pledge contributions via the Internet has become increasingly common during the past several years. But many of the individuals and organizations that have received cash using such websites as Kickstarter and Indiegogo have put the money to work on small, personal projects or nonprofit ventures.
In 2012, the Obama Administration backed passage of the JOBS (Jumpstart Our Business Startups) Act, which among other things created a federal exemption under securities laws that would expand the use of crowdfunding to include the marketing of shares in budding companies.
In the past, the only SEC-approved way for a business to raise capital in a public marketplace required that an enterprise go through the lengthy and costly process of registering its securities – stocks or bonds – with the federal agency. Following approval and publication of the registration statement, the enterprise had to honor a “quiet period,” during which it could not discuss or promote its mission, before finally offering the securities for sale on a public exchange.
The cost and complexity of the process had the effect of limiting public stock offerings to large or medium-size enterprises that had substantial revenue and a lengthy financial history.
But the new SEC rules, which will go into effect at the end of January 2016, will exempt, with some conditions, qualifying entities from the onerous registration requirements that have largely been in effect since 1934.
“There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendments provide smaller companies with innovative ways to raise capital and give investors the protections they need,” SEC chairwoman Mary Jo White said in releasing the regulations.
She noted that the rules also provide a process for registering web portals and online broker-dealers that businesses will have to use in order to offer their securities online.
While the crowdfunding rules could launch a new era in capital raising for small businesses and startups, they don’t “undo” the regulations that have long governed offerings by companies looking to raise tens of millions of dollars or more in a single sweep.
But for smaller enterprises that have traditionally had to beg, borrow and do everything short of stealing the money they need to get their business rolling, the changes could significantly expand their opportunities.
The final SEC rules limit the amount of money an issuer can raise in a crowdfunding campaign, and they do impose disclosure requirements on issuers, who must provide certain basic information about their business and the securities they are offering.
In addition, the rules establish certain restrictions on investors who wish to participate in a crowdfunding offering. The investors will be subject to limits on how much they may invest, and they must meet minimal net worth requirements to become accredited investors under SEC rules.
But restrictions aside, there’s no question that the SEC is making capital much more accessible to entities that in the past would have faced a harder struggle for financing. And this loosening of the reins raises new questions, such as: Will crowdfunding prove to be a secure means of financing new enterprises, or will it become a haven for shysters looking to take the money and run?
And what about the long-range viability of companies that legitimately raise money through crowdfunding? The easing of requirements won’t do anything to increase the likelihood that a young business will survive past the five-year time span within which startups generally fail.
Michael Johnson, managing director at longtime local venture capital firm Advantage Capital Partners, points out that while raising money can be difficult, it isn’t necessarily the biggest challenge a budding business will face as it seeks to become established.
“Entrepreneurs tend to need more than just capital,” Johnson says. “ Firms like ours work extensively with our portfolio companies, often providing insight, access and connections that can be quite valuable to them.”
He says that while crowdfunding may increase competition for companies that provide early-stage business funding, “there should still be a big role for professional venture capital firms and the experience and expertise they can provide to young companies.”
Watch for more debate over the extension of crowdfunding into the venture capital arena in months to come.
The October Biz column incorrectly listed as winners all five finalists in Propeller’s 2015 Water Challenge competition. The only winning enterprise was Wetland Resources LLC, a project of Gary Shaffer and Demetra Kandalepas. Finalists were: Advanced Berm Technologies (Don and Jon Adams); Greenman Dan Inc. (Dan Johnson); Magnolia Land Partners (Mark Bernstein); and Riverbottom Tech (John Tesvich).
Transactions under the new crowdfunding rules are subject to dollar limits on both issuer and investor.
The issuer may not sell more than $1 million worth of securities during a 12-month period.
Investments are limited to:
1) The greater of $2,000 or 5 percent of the lesser of the investor’s annual income or net worth, if either is less than $100,000; or
2) 10 percent of the lesser of annual income or net worth if both are above $100,000.
See sec.gov for more information