Congress created equity crowdfunding, but the Securities and Exchange Commission holds the infant industry’s life in its hands.
The Jumpstart Our Business Startups Act, passed almost a year ago, will let privately held companies sell up to $1 million a year in unregistered stock to mom-and-pop investors using the Internet and social media. But they can’t start until the SEC completes the regulations.
The SEC missed its Dec. 31 deadline for publishing the regulations. Given its backlog of rule-making and the fact that its new chairman hasn’t been confirmed, it could be next year before a rule takes effect.
SEC spokesman John Nester would only say, “We will continue working hard amid a busy rule-making agenda to get these crowdfunding rules done as soon as possible and to get them right.”
The SEC will have to balance the capital-raising needs of small companies with the need to protect investors with limited wealth and financial savvy.
Some critical questions remain – how much disclosure companies will have to provide investors, how much personal liability they and their directors will bear for misstatements or omissions in disclosure documents, and whether crowdfunding portals can curate or choose which companies are listed on their platforms.
If the regulations are too onerous, some fear the most promising companies will seek funding through traditional channels – such as venture capital and angel investors – and only the most desperate will use crowdfunding.
If the regulations are too weak, there will be even greater potential for fraud. If investors can’t make money over the long term, there will be no crowdfunding industry.
“The SEC can make it or break it through their rule-making,” says Naval Ravikant, founder of AngelList, an online platform that helps entrepreneurs find accredited investors.
Already, hundreds of companies are forming to provide portal and other services to the equity-crowdfunding industry, and many of them are looking for investors themselves on AngelList. There could be more people “making picks and shovels than there are miners out there,” Ravikant said during a crowdfunding event at Stanford Law School Thursday.
No equity ownership
Many private companies and nonprofits have used crowdfunding platforms such as Kickstarter and Indiegogo to raise money for projects in exchange for free products, access to events or a warm fuzzy feeling. But companies cannot yet offer equity ownership this way.
Today, companies that want to sell stock generally must register it with the SEC – a long and costly process that typically leads to the company going public – unless they meet certain exemptions. One exemption lets them sell unregistered stock to accredited investors, which generally includes institutions and affluent individuals.
The individuals must have earned at least $200,000 in each of the past two years ($300,000 if married) or have at least $1 million in net worth excluding their primary residence. That’s about 3 percent of the population.
The crowdfunding provision creates an exemption that will let companies sell up to $1 million in unregistered stock every 12 months to an unlimited number of investors who need not be accredited.
The transaction must go through an intermediary, either a broker or a funding portal. The intermediary must register with the SEC and a self-regulatory organization, make sure investors understand the risks and conduct a background check on the company’s officers, directors and large shareholders. They are also supposed to make sure investors don’t exceed their investing limit.
The most one person can invest in all crowdfunded securities combined in one year is:
— The greater of $2,000 or 5 percent of annual income or net worth (excluding a home) if the person’s annual gross income or net worth is less than $100,000, or
— 10 percent of annual income or net worth, up to $100,000, if the person’s income or net worth is at least $100,000.
Source: SFGATE / by Kathleen Pender, Chronicle Columnist