What regulation crowdfunding in the JOBS Act means to entrepreneurs and startups
The JOBS Act was signed into law by President Obama in 2012, allowing companies to acquire funding through online portals from non-accredited investors, which roughly accounts for 97 percent of the population in the United States. On May 16, 2016, Title III of the JOBS Act, also known as regulation crowdfunding, or equity crowdfunding, was the last section to be implemented by the SEC.
With such a large pool of potential investors looking to enter the market, it would seem that the crowdfunding and investment communities would be extremely welcoming of Title III — but it seems like the exact opposite is happening. This could be because not enough is understood about this type of crowdfunding. As a founder who has tried all types of crowdfunding, I’ve seen significant benefits to all platforms, including equity crowdfunding.
How is equity crowdfunding similar to or different from other crowdfunding?
Equity crowdfunding shares similarities with Kickstarter campaigns in terms of how a company must spread their message to potential investors about their products in order to successfully raise enough funding. However, the main difference between equity crowdfunding, rewards-based crowdfunding and donation-based crowdfunding is the investor’s end goal in rewards-based crowdfunding, such as Kickstarter and Indiegogo. Rewards-based fundraising is aimed at enticing investors based on the benefits they would receive in relation to the amount they contribute.
As a founder, I’ve used this type of crowdfunding, and have helped others do so with great results. It’s been ideal for taking a prototype to the next level because those investing are excited about the concept they see and are incentivized to invest because they will most likely be one of the first to receive the new product. I’ve experienced wildly successful rewards-based crowdfunding; it’s been the reason our company could move to the next level in our development.
Donation-based crowdfunding seeks funding that comes as goodwill from the community. This method is geared toward charitable contributions rather than capital acquisition, which is the aim of equity crowdfunding. When investing through equity crowdfunding, an investor receives shares in the company instead of a final product, which tends to yield a greater benefit for the investor long-term. The way the shares are structured allows the founders to retain control of their company even after selling a portion of their equity to multiple investors across the country.
Of benefit or concern?
While equity crowdfunding was developed with the intention of providing significant benefits, many have professed some major concerns related to how equity crowdfunding might change the funding landscape. The major concerns include the numerous intimidating filing requirements that entrepreneurs must fill out for the SEC, the need for constant reporting to the SEC, the requirement that company financials be made available to investors and the review or audit of financials by an accountant based on how much you have raised.
However, others believe these requirements are justified. Manny Fernandez, CEO and co-founder of Dreamfunded and the 2014 Equity Crowdfunding Leadership Award recipient, notes, “When a company is just starting, transparency in terms of financials is irrelevant because there is nothing to hide from potential investors. This is one of the various ways in which established investors are trying to maintain control of entrepreneurs and prevent them from finding alternate funding opportunities apart from the traditional methods. It makes good business sense to all involved.”
Do your research, understand what is involved in terms of benefits and risks and determine how you could use the funds wisely.
Another concern has been the liability companies might face when an investment venture, failing to generate any returns or growth, shuts down. A decision such as this made by founders may motivate some jilted investors to seek compensation for their lost investment. However, when an entrepreneur fills out a Form C, full disclosure is made to potential investors about the risks, which are associated with investing in the company.
It is highly unlikely that any disgruntled investor would be able to win any lawsuit seeking reparations as long as general risks involved in their investment are disclosed to potential investors. Also, investment limitations based on income level have been established by FINRA and the SEC to help investors not risk their entire pension or life savings by making one bad investment.
Another issue has been the fact that because there tend to be smaller investment amounts with equity crowdfunding, the cost of using this type of crowdfunding platform might outweigh the benefits of it, as smaller individual investment amounts may raise the amount of investors on the cap table. In addition, the fee charged by funding portals reduces the total amount raised. However, although the amount per investor is smaller, there is also a larger amount of people who are helping you watch the business grow.
For me, as an entrepreneur, I’ve spent a considerable amount of time and money looking for potential investors for my digital wallet startup who are not always readily available, in the local area or willing to invest in the idea that they are pitched. Instead, with equity crowdfunding, I pay a fee and then get access to more investors, which has saved me considerable time, money and effort, as well as enables me to get started on building out my company sooner.
One of the greatest benefits with equity crowdfunding is that I can set my own terms for the shares of the company, providing me with more autonomy and freedom. The shares sold through equity crowdfunding are limited to only one class of securities, so there are no voting rights. Instead, the investor is simply investing in the company’s profitability and success. This process has helped me maintain control and minimize any potential threat of investors commanding the direction of the company during the early stage of fundraising.
Some entrepreneurs have expressed their dislike of the fact that there is a fundraising limit of a million dollars over a 12-month period. However, it’s important to remember that this type of funding is typically only for the first round, and it can be used again for future stages of growth or other types of funding can be implemented at that point. Also, some of my companies started on much less funding and I was able to leverage more funding through equity crowdfunding at a later stage when I really needed a larger amount.
Proposed changes to Equity Crowdfunding Act
In March of this year, before Title III was implemented, the Fix Crowdfunding Act bill was introduced into Congress to address and improve upon some of the shortcomings of the current legislation. The first proposal is to increase the annual fundraising limit from $1 million to $5 million, which allows entrepreneurs who require larger amounts of capital in the seed round to use equity crowdfunding as a potential source of funding.
The second proposal is the “test the waters” provision, which allows entrepreneurs to gauge the interest of potential investors through an online portal before they take the time, effort and money to extend an initial offering. The third proposal is to allow for the use of SPVs (special purpose vehicles), which would help entrepreneurs keep their cap tables organized because the investors of low-dollar amounts are grouped together into one large fund that appears on the cap table as one large entity. These proposed fixes are now up to the Senate to decide, and it will take at least a year for it to be passed.
A guide to using equity crowdfunding
In the meantime, I highly recommend considering equity crowdfunding, as it has offered an additional avenue for funding without having to contend with investors who want to take over and run my business.
As an entrepreneur, I know that risk is just part of the game. If I always played it safe, I wouldn’t be here today, with a rapidly growing online invoicing and payments business. The risk involved with equity crowdfunding is minimal. What I always recommend before using any kind of funding vehicle is to do your research, understand what is involved in terms of benefits and risks and determine how you could use the funds wisely at a certain stage in your startup’s development.
Today’s equity crowdfunding marketplace also has credible platforms that are driving greater success for those using this funding source and connecting more entrepreneurs quickly to the investors they need to become successful.