Has crowdfunding for equity arrived?
The excitement surrounding crowdfunding has been growing ever since the JOBS Act was signed by President Obama in April 2012.
In addition to lifting the ban on general solicitation and advertising in specific kinds of private placements and creating the category of “Emerging Growth Company,” (which helps small companies avoid most SEC regulations and fees in the first few years of being public), the JOBS Act also included the Entrepreneur Access to Capital Act which opened up crowdfunding to the general public as a means of raising equity capital. This section has received a lot more attention than any other part of the larger Act, but just what does crowdfunding for equity entail, and when is it going to be available to companies and investors?
First, let’s take a look at the various categories of crowdfunding that exist. Good-cause crowdfunding is perhaps the earliest form of crowdfunding going back many years. Example sites include StartSomeGood and the Facebook Cause page. In this form of crowdfunding, people can donate money to a project which has good moral/ethical value. Donors simply enjoy the feeling of doing good; there is no financial return for giving.
Next is rewards-based crowdfunding, which is probably the most well-known form to date. This type of crowdfunding gives donors the satisfaction of helping, as well as a pre-determined reward that has some sort of value, such as a t-shirt or other recognition. In this case, no equity or finished product is provided to the donor. A good example site, and one of the earliest in this category, is IndieGoGo.
Another popular form of crowdfunding right now is pre-order crowdfunding. This type of crowdfunding allows people to pre-buy a product by making online pledges with their credit cards during a campaign. If the product is ever built, the donor receives his or her purchase at a later date. Kickstarter is the big player in this space. In this form of crowdfunding, there is no equity purchase involved. The only ROI is the product itself.
Debt-based crowdfunding is sometimes called micro-financing or peer-to-peer (P2P) lending. In this model, entrepreneurs borrow money from a number of people online and pay them back after the project is finished. While not as well-known in America, sites such as LendingClub and Kiva have made this format popular in many other countries for years. While there is no equity transaction involved, it is an investment deal with the potential for fat returns. With high reward comes high risk, however, as some of the loans are never repaid.
What the JOBS Act is dealing with is the concept of startup equity, specifically for “regular” people. Accredited investors have been able to engage in equity crowdfunding for several years using a small number of select platforms that act as registered brokers. The Securities and Exchange Commission defines an accredited investor as someone with a net worth of at least $1 million, or who has income of more than $200,000 in the previous two years. Anyone who falls below those thresholds is considered unaccredited. The JOBS Act, however, allows large numbers of unaccredited investors, regular people, to invest small amounts each online via funding portals to fund early startups. This is not a get-rich-quick vehicle for any investor, however. Investments in startups are far more risky than the commodity markets, and investors shouldn’t expect to see any return for five years.
So, what is the status of crowdfunding for equity? Frankly, it’s stuck in Washington, at the Securities and Exchange Commission to be exact, winding its way through the rulemaking process. On October 23, 2013, the rules regarding crowdfunding for equity were published for public comment. Hopefully they will be finalized in the first quarter of 2014. But some states, namely Georgia, Kansas, and Michigan, are not waiting for the federal government to make the rules. They are making their own rules!
On December 30, 2013, Governor Rick Snyder signed Public Act 264. This new state law, similar to the laws in Georgia and Kansas, will allow unaccredited investor to invest up to $10,000 in a project via online pledges through crowdfunding portals. The Michigan law will allow a business to accept up to $1 million from unaccredited investors if the business cannot provide certified financial audit to investors. The investment cap is raised to $2 million if the company has audited financials. What’s the catch? The businesses seeking investment must be located in Michigan AND all unaccredited investors must be located in Michigan, too.
Some of the details of the Michigan law require that a business must have business and financial plans for investors to see, and investors have to sign a document stating they understand they are investing in a high-risk, speculative business venture that risks their entire investment. Also, the law stipulates that invested funds raised via a crowdfunding platform be placed in an escrow account and that the business cannot have the funds until the minimum amount specified in the business plan is reached. If the company cannot raise that amount in the stated time frame, investors can cancel their commitments. And that is kind of where Michigan is right now—the escrow stage.
There are several Michigan portals ready to launch as soon as they can find banking partners to open up the escrow accounts. Rumor around the state has it that US Bank and Huntington are the leaders out of the gate, but neither has set anything official in motion. In the meantime, anyone interested in learning more about the equity crowdfunding portals poised to launch in Michigan can look at sites such as these: