WASHINGTON, DC – APRIL 5: U.S. President Barack Obama signs the Jumpstart Our Business Startups (JOBS) Act in the Rose Garden of the White House on April 5 2012 in Washington, DC. (Image credit: Getty Images via @daylife)
There has been both much buzz and confusion around crowdfunding. On April 5th 2012, President Obama signed the JOBS Act (shorthand for Jumpstart Our Business Startups) into law, which changed numerous components of the Securities Act of 1933, and is the legislation that largely deregulates equity crowdfunding.
The SEC is still in its rulemaking phase, so equity crowdfunding portals can’t assist under the new law just yet. Meanwhile, many are wondering how this enabling legislation changes things; some continue to understand crowdfunding based on the sites that exist today.
It’s true, crowdfunding as a concept is not new or novel by any means. Even as far as IPOs go, there are a large number of investors (a “crowd”, if you will) that gather together to purchase stock in an IPO. Charities have always used the crowdfunding model in tandem with large foundations provided by wealthy philanthropists. We have seen in it action for a long time, and recently we have seen its power when combined with the Internet and social media.
With sites like Kickstarter and Indiegogo posting anything from vacation requests to product developments, there have been a wide range of campaigns and requests that have been funded. However, the money that is raised for existing sites is neither for repayment or a stake in the profits (if applicable). In general, they offer ‘perks’ or ‘gifts’ that incentivize supporters to finance the campaigns. This part needs to be made crystal clear: even if the money is being raised to help start a business, the supporters cannot be financially compensated based on its success.
This is due to the fact that the Securities Law of 1933 mandated prohibitively high requirements for disclaimer, disclosure and reporting that made it nearly impossible for the average startup to raise money without incurring extremely high accounting and legal costs. Additionally, even with the advent of the Internet and social media, startup companies were not permitted to request the support of their community to invest in their business.
This is a lot of information to absorb, but prior to the passing of the JOBS Act the facts (according to the U.S. Securities and Exchange System) were as follows:
- The everyday person is legally permitted to gamble or give away as much money as one wishes
- The everyday person is not permitted to invest discretionary capital into high growth startup companies. With proper disclosure, only sufficiently wealthy people are permitted to do so.
- Startup companies are not permitted to solicit the support of their communities and networks for investments, but are permitted to solicit donations without limit
Soon, with the passage of the JOBS Act and completion of SEC rulemaking, startups and businesses will be able to raise and gather smaller (limited to the maximum 2% of income or $2,000 for individuals making less than $100,000 a year and the maximum of 10% of income or $100,000 for individuals making more than $100,000 a year. These are annual limits.) investments from their supporters to aggregate a meaningful amount of capital to get off the ground. It’s a fantastic development in early stage finance that has the potential to disrupt the very way in which early stage startups get off the ground. While capital is not the only startup requirement for success, it is potentially a huge boost for entrepreneurs, to be able to more easily raise the capital needed to grow and develop their businesses.
With equity crowdfunding, each and every investor will have an ownership stake in the company. If the company succeeds, these investors can get a windfall by providing this early stage capital to startups that had a great idea.
Perhaps its benefits will become clearer from a real example. When Facebook was in its early stages, and if the company had chosen to use crowdfunding for its capital raise, many investors would most likely have had very small equity stakes. For a sense of scale, a 1.00% equity stake at the time of Facebook IPO would be approximately valued at $1,000,000,000, while a 0.10% equity stake would be $10,000,000. This provides a perspective to glean the potential for crowdfunding investors. This is not to say that every startup will be a huge blockbuster, however there are countless successes out there that often receive less press, but generate significant value for their investors and stakeholders.
Everyone is still eagerly awaiting the regulations that have yet to be released by the SEC. However, there are things that are clear today: the worlds of of business and investment are on the cusp of a revolution that will propel us into the future much faster than we had anticipated. Potentially high impact startups, new technologies and the most innovative of sustainable businesses will no longer have to fall by the sidelines, but now will have more of a fighting chance to grow into meaningful and ongoing businesses that will shape the very way we experience our lives.
By Sang Lee