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.
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.)