Spend a little time in the startup world and you’ll quickly become familiar with crowdfunding, from consumer platforms like Kickstarter or Indigogo to the new equity crowdfunding models. Launching a crowdfunding campaign is becoming a great way for startups to gain exposure while generating financial support for their project – and in the same time, validating it.
So how does it work? Supporters that contribute funds for a startup’s cause, known as “backers,” generally receive an item in return, whether a token of the startup’s appreciation or an early version of the product.
For a famous example, consider the Oculus Rift. In 2012, Oculus Rift ran a KickStarter campaignthat raised $2.4 million. Contributors received everything from T-shirts to a prototype kit. Just four years later, Oculus Rift was acquired by Facebook for $2 billion. If this was an equity situation, investors would have received a 145x return. And that’s where equity crowdfunding comes in
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Over 3 years ago now, the U.S. Security and Exchange Commission (SEC) compiled the JOBS Act laying the foundation for investment opportunities in the 21st century. Title III of this bill had language geared towards equity crowdfunding but lacked clarity until earlier in July. Of course hundreds of pages of legal jargon isn’t something me and you would enjoy “clarifying” per se, so let’s overview some of the most exciting provisions of this bill.
Startups Can Raise $1 Million Max Per Year; But There’s a Catch
“Only $1 million?! Really?!” If you were one of the individuals hoping that the SEC would increase the maximum higher than $1 mill, Title III does not allow such terms. However, Title IV (Regulation A+) of the JOBS Act mentions that startups have the opportunity to raise up to $50 million by holding a mini Initial Public Offering (IPO) for their campaign.
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Accredited Investor? I Think Not!
Over the past couple of years, there has been debate over who can partake in equity crowdfunding. At first, if you weren’t an accredited investor, you were not eligible to contribute towards an equity crowdfunding campaign. In order to fall into this category, you had to make at least $200,000 per year and have a working networth of a minimum of $1 million. This requirement greatly limited investor access considering less than 3% of American citizens are presently considered accredited. The JOBS Act eliminates this criteria so now anyone can contribute regardless of their annual income. However, there are still limits to how much a backer can contribute.
The SEC actually tightened the limits allowed for contributors to invest. According to the codes, investors are limited to, “(a) the greater of $2,000 or 5 percent of the lesser of their annual income or net worth, if either the annual income or the net worth of the investor is less than $100,000 and (b) 10 percent of the lesser of their annual income or net worth, if both the annual income and net worth of the investor is equal to or more than $100,000.” In other words, the ceiling stops at $100k for individual investment.
Equity Crowdfunding is Affordable for Startups
One of the biggest concerns was a past proposal requiring startups to conduct a full financial audit before launching a campaign. Of course this would cost tens of thousands of dollars that could be better channeled towards more important business expenses. Fortunately, the SEC agreed that this proposed requirement was a little excessive and not realistic for many emerging startups. They rejected this provision and replaced it with much more reasonable provisions. If a startup using equity crowdfunding wants to raise more than $100,000, financial review records are required. In addition, if a company’s end goal is less than $100,000 they have even fewer financial requirements.
With great opportunity comes great responsibility so please don’t cut corners on what’s required with equity crowdfunding. Startups have to disclose all of the campaign’s information from start to finish. This includes security values, the target amount, target deadline, and other important variables. The SEC needs to stay in the loop at all times so there will be a lot of logistics, business descriptions, employee profiles and other assignments that entrepreneurs will have to complete. Most importantly, equity crowdfunding is the sale of securities and these laws vary by region. You want to assure that you have crossed your T’s and dotted your I’s on all of the state and federal requirements for the sale of securities. If not, it is possible to be charged for violating a required financial mandate. And believe me, that’s no fun. Your best bet is to educate yourself and your team on what’s required on a state and federal level to avoid any complications.
The JOBs act has become law as of May 2016. I expect to see a surge of crowd funding platforms to emerge in the near future. Indiegogo has announced that they will develop an equity crowdfunding service. The Startup Hour is planning a Shark Tank like television show that will allow the audience to vote on featured startups with their dollars and receive equity in return. For startups, equity crowdfunding will be another great resource to raise funds.
By Rich Foreman, CEO / Apptology and Director of Startup Grind Sacramento. Rich co-authored the book Tap into the Mobile Economy and his blog has been listed in the Top 20 Mobile Marketing Blogs of 2014. Follow Rich on Twitter at@ApptologyCEO or attend a Startup Grind Sacramento Event.