Crowdfunding can be a misunderstood term and as a funding option, has not been nearly as widespread or readily available as believed. The concept seemed simple enough; large numbers of people could just fund your startup if they chose to.
However, that notion of crowdfunding was not available because the U.S. Securities and Exchange Commission (SEC) did not have investor protections in place and therefore could not be treated as securities offerings. The SEC has recently issued rules clarifying who can invest, and who can access crowdfunding capital.
As a result, you are now free to invest in startups and have others invest in yours, subject to the SEC’s conditions.
By a 3-1 vote, the SEC permitted equity investing via crowdfunding portals. Generally speaking, the conditions are that the offerings must be made through brokerage firms or crowdfunding portals that are required to register with the SEC.
These portals will be required to vet the companies and prospective investors, and provide materials to investors that explain resale restrictions, investment limits, and the process. Such disclosures serve a similar function as a stock prospectus.
The risks to investors can be substantial, as the new SEC rules will not prevent common fraud from online scams. According to Mercer Bullard, a law professor at the University of Mississippi, a mutual-fund investor advocate, the potential for fraud is real.
In a recent U.S. News and World Report interview, he warned that people can, “…embezzle someone’s money in the guise of making a securities offering”.
The rules will take effect in mid-2016 and startup companies will now be able to legally sell stock online through the portals and brokerage firms.
Under the new rules, individuals with net worth or annual income of less than $100,000 will be allowed to invest a maximum of 5 percent of their yearly income or net worth, or $2,000 if that is greater. Those with incomes greater would be able to invest up to 10 percent. An individual cannot invest a total of more than $100,000 in all crowdfunding offerings during a 12-month period.
The portals will now bear some resemblance to investment bankers.
Crowdfunding in recent years has been associated with the creative class; artists and musicians. In exchange for funding now, you receive discounted works of art or music. It was a form of “bridge” financing. Entrepreneurs could pre-sell products or services to launch a business without incurring debt or sacrificing shares or equity.
Now that equity crowdfunding is available, backers can receive shares of an early-stage company in exchange for money invested.
Who are these portals? There are many. The leaders in the crowdfunding industry are poised to become major players in equity crowdfunding. The top crowdfunding platforms are GoFundMe, Kickstarter, and Indiegogo. Each of these platforms allow you to run a funding campaign and will charge fees of 5 percent on the funds you raise, in addition to wire and credit card processing fees.
There have been ways of lending and borrowing money directly between individuals on peer-to-peer lending platforms. One example is Prosper where funding a startup business is now an allowable use of loan proceeds. This platform connects people (investors) with funds to lend and borrowers. The borrower completes an application and Prosper generates a credit score. The borrower is also able to submit a statement describing who he is as a person, community activities, and other intangible qualities. This lends a human touch to the normally objective and quantitative business of lending. Another example is LendingTree.
Thanks to these portals, you can now take it to the streets and quite possibly avoid the banks.