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There’s more to crowdfunding than Kickstarter and the like. They pre-sell. That funding gets you product, not equity. This post is an update on the JOBS Act which was signed into law in April of 2012 and has since been winding its way from general legislation to specific regulation. When finally implemented, the law will hopefully make it much easier and cheaper for small ventures to get funding-for-equity from the crowd.

This legislation delivers two changes which most interest makers. Currently only 2 percent of Americans have the financial resources to qualify as “accredited investors” who are exclusively allowed by law to invest in higher risk investments. Title 3 of the new law greatly expands who may qualify to make smaller investments in emerging growth companies. Currently accredited investors may learn about investment opportunities only by means of private communication. Title 2 of the law will allow public solicitations rather than the traditional private placements and thereby greatly expand awareness.

To get an update I turned to Paul Spinrad. Spinrad (a former executive editor at MAKE) played a key role in bringing these changes to life and has written extensively on the topic. Paul and Jenny Kassan of Sustainable Economies Law Center collaborated on a proposal for a new exemption, that after much modification, became legislation. Paul was actually at the White House Rose Garden for the Presidential signing ceremony. This is a subject he’s passionate about and that he follows closely.

Here’s the update I got from Paul. Existing securities law draws a distinction between investors who are deemed “accredited” because of their high wealth or income, and “unaccredited,” the less wealthy, who currently comprise 98 percent of the population. In general, accredited investors can invest in anything they want to, while unaccredited investors can only invest in offerings that are registered with the SEC or a state’s board of corporations– a process that requires tens or hundreds of thousands of dollars, putting it out of reach for independent makers and most small businesses. In effect, this has created a monopoly on the investment accounts of the non-wealthy, eliminating their ability to put their money into anything small, local, or otherwise not on Wall Street’s menu.

President Obama signs  the JOBS Act at a Rose Garden ceremony.

Title 3 will allow anyone, including unaccredited investors, to invest via an online intermediary in securities that need not be registered. Of course, these investments will likely present a higher risk than most registered securities, so for investor protection, the amount that you can invest annually in a Title 3, crowdfunding-exempt security is capped at $2,000 or 5 percent of income for individuals with incomes less than $100,000 and 10 percent of their income, up to $100,000 for people who make more than $100,000 per year. Companies tapping this crowdfunding market are capped at raising $1 million per year, but are not limited by number of investors. Since this allows funding from a huge audience, this is great news for professional makers. While Title 3 of the JOBS Act was to be implemented by Jan. 31 of this year,  it’s been delayed and first quarter of 2013 is now the more likely time frame.

Two types of online intermediaries will host crowdfund investments: existing brokerage houses that have broker-dealer licenses, and a new entity called a funding portal, which is like a lightweight broker dealer that can’t carry other traditional types of investments, can’t make recommendations, and are subject to other restrictions. These “Kickstarter plus” (or “Schwab minus”) websites should be cheap, efficient, and greatly expand awareness in the crowd.

Title 2 will allow “private equity” investment opportunities (which are unavailable to unaccredited investors) to be communicated publicly rather than just privately. For all investments this will greatly increase awareness of funding opportunities. Title 2 was to be implemented in July of 2012 but is now expected to be completed by year’s end.

For all this good news there are concerns. Until this new market matures, some worry that unsophisticated investors could be duped. Furthermore many feel that FINRA (the Financial Industry National Regulatory Authority, formerly the National Association of Securities Dealers, is the securities industry’s self-regulating organization and will now oversee funding portals) is not preparing with sufficient haste. A delay in operational preparedness could favor the traditional broker-dealers and hurt funding portal ventures. While Paul acknowledges these issues, he isn’t concerned for the long term.

“This is a new revolution of grassroots empowerment,” he says. “Around the world, crowdfunding is taking off, spurring innovation, and helping people pursue their dreams. Other countries have introduced crowdfunding exemptions, most recently Italy, and some states are looking into more local versions as well. If the new federal crowdfunding legislation doesn’t work out, we’ll fix it.”

Brace yourself, crowdfund investing will be arriving soon.

(To stay on top of developments bookmark Paul’s Crowdfunding Law blog.)

Travis Good

Speaker. Maker. Writer. Traveler. Father. Husband.


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Comments

  1. [...] Read the full article on MAKE [...]

  2. Well, I’m glad the government is there to protect me from myself. I can’t be trusted to make good decisions, you know, so they might as well just go ahead and make them for me.

    1. Analyzer says:

      What are you talking about? Where does this article say anything like that?

      1. Darrick says:

        That is exactly what this says. They are limiting the amount you can choose to invest. This is to protect people by removing their ability to judge what their personal maximum investment should be in something. By limiting how much you can invest, they limit how much you can loose, but also how much you can make.

        1. These limits are kind of sad when you think about them. $2000 max per year? I could easily get 3 or 4 credit cards and max them out to get $50k in leveraged funds…..and then have my project tank and me left with all the debt. But getting 5 people to chip in $10k capital each…well, gosh, that’s just too dangerous!

    2. Alan Dove says:

      No, it does exactly the opposite. Previously, you couldn’t invest AT ALL in these types of efforts. The law limited you to zero investment – unless you happened to be in that rarefied 2% that qualified as “accredited investors.” Now the rest of us can actually put money into early-stage startups we think might work. The government just increased the amount of money you can risk in early-stage startup ventures by a factor of infinity. That kind of deregulation is a two-edged sword, though: it would be very easy for scammers to rob people blind this way. The investment cap is designed to limit shenanigans. If things go well, Congress could also increase the cap quite easily, now that the basic legislation is already in place.

      1. Robert Vincent says:

        This is patently false, “Friends and Family” investors are rarely accredited and are at the core of most startups. The change is that you can now make public mass solicitations for non-accredited investors – previously the solicitations had to be done in private.

      2. greggie says:

        No, I’m glad to see it loosen up, and I realize this is what happened. I was annoyed at them telling me how much of my own money I can invest. At one point I invested three times my yearly income (WELL below 100k, close to the poverty level) in my business and have been rewarded handsomely for it. The government is supposed to be there to provide basic services and protect us from others, not ourselves.

        Investment is inherently risky. So what, there are no federal protections on how much debt an individual can accrue (a liability), how much money you can pay a shady contractor in advance for a house, or what you can pay for a lemon car. I wish they would leave me alone.

  3. One small fact was left out, the wording of the legislation, written by attorneys, is a legal nightmare for companies. If the startup company fails, the legislation holds the company liable for virtually all of the losses experienced by the non-accredited investors (there is no protection for missed projections – obviously the evil company was lying to dupe people out of their money). This was a corporate attorneys dream come true. Just watch, early adopters of this funding avenue are going to be killed by law suites. Once again, government favors lawyers, moochers and looters – setting up producers to be exploited. I highly recommend anyone considering this funding route consult a trustworthy corporate attorney first – or prepare for impending bankruptcy by opening themselves to endless lawsuits every time they miss a sales or development projection.

    1. Alan Dove says:

      Ever seen what happens to a biotech startup after a failed clinical trial? Liability is just a normal part of courting investors. Startups should absolutely consult an attorney about “forward-looking statements” and other potential booby traps, but that was true before this law, too.

      1. Robert Vincent says:

        Yes, true enough, liabilities are everywhere but they are well defined and procedures have developed over the years to make them palatable to both investors and businesses alike. This law has thrown that balance and limited the effect of virtually all established processes when dealing with the non-accredited investors. It is so bad that all of the investors I know will not touch a company that is going down this road.

  4. Greg McClure says:

    And yet another reason why I call this the Kill JOBS Act. This nanny state crap has to go.

  5. [...] Exemption, help rekindle the crowdfunding idea in a rather interesting way. Thanks to the Jobs Act, “a new era of crowdfunding” may very well be unfolding as “the law will hopefully make it much easier and cheaper for small [...]

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