The model of crowdfunding platforms such as Kickstarter is on its way to providing investors with another way to get involved in alternative finance: equity crowdfunding. In the US, the “Jumpstart Our Business Startups” act, signed in 2012, aims to relax securities regulations in order to boost funding for small businesses. In particular, parts of the bill are intended to encourage raising money by allowing investors to purchase shares of start-up companies when there’s plenty of growth potential to be materialised.
Recently the SEC approved a set of rules which allows for this to occur, under careful regulation.
Current US legislation
Due to the risky nature of start-up firms, the SEC has taken action to ensure that the risks that angel investors would be exposed to are limited: per year, companies can raise a maximum of $1 million and each investor can contribute up to a maximum of $100,000, having to hold their stocks for at least one year. In addition, individuals with a net worth under $100,000 can invest up to 5% of their wealth, and individuals with a net worth above this threshold can invest up to 10%- with said $100,000 cap.
The SEC also stated that companies that have raised between $500,000 and $1,000,000 don’t need to produce audited financial results, which has been called a wise move in the support of small businesses, as the costs of producing such results are greater than the benefits would be. The results will simply have to be reviewed by an accountant.
Overseas, equity crowdfunding has reached varying degrees of integration, being completely illegal in Singapore (together with all crowdfunding platforms), and being regulated but legal in Canada, Scandinavia and certain European countries.
While the equity crowdfunding movement has faced criticism for being reckless and risky, some claim it is still too regulated for its own good: Michael Piwowar, SEC Commissioner, stated that strict legislation could backfire. He claims there are traps hidden in the new regulation, which will be a burden for small businesses which don’t keep regulatory compliance as a top priority, thus reducing the appeal of equity crowdfunding in the first place.
On the other hand, others prefer to remind potential investors with low net worth that while venture capital investments can be a great way to see dreams of a product materialise, they can be painfully unprofitable. One of the main concerns of the risk-averse crowd is the possibility that equity crowdfunding opens up for fraud. Small businesses could suffer if the market turns out to be a magnet for financial malpractice, harming investor confidence the way the penny stock scandals of the 1980s did. The SEC is trying to tackle such risks by allowing equity crowdfunding to take place only through intermediaries such as licensed brokers or a Funding Portals registered with the SEC, which are not allowed to make any sort of buy recommendation.
All in all
Equity crowdfunding can prove to be an effective way for investors of all calibre to get involved in helping startups grow, creating a market that encourages entrepreneurs to get shareholders involved in the early stages of their businesses. Regulation is currently aimed at reducing the risks for both the investors and the businesses, and while a legislative equilibrium is far from being settled, this market may play a progressively important role in the world of venture capital.