Start-ups Wars: The New Financing Force Awakens in 2016

2016 marks the start of a new era in venture financing and capital formation and if you are an entrepreneur searching the galaxy for capital, well, to borrow a Star Wars saying - May the Force be With You.

The Force I'm referring to is the emerging army of individual (retail) investors who were historically cut out of the private investment opportunities available to institutional or accredited investors only.

Not anymore.

The force has been unleashed this year by the Securities and Exchange Commission (SEC) which after years of legislative work and eloquent debates, has moved forward with two main provisions of the JOBS Act signed into law by the President back in 2012.

The highly anticipated legislation has widened the pool of potential investors you can approach, adding non-accredited, aka the crowd.

Now grab your popcorn and enjoy.

Raising Equity From People in Cyber Space: Learning the Rules of the Game

Supreme Leader Snoke: There's been an awakening. Have you felt it? The Dark side, and the Light.
- Star Wars: The Force Awakens

The most important thing to remember - equity crowdfunding is highly regulated; its legislation consists of hundreds of pages so make sure to get acquainted with:

1) Actionable Title IV of the JOBS Act (often referred to as Reg A+) which went into effect on June 19th, 2015;
2) Title III rules that were announced in October of 2015 and are set to go into effect on May 16, 2016 (now in the comment period).

I am certainly not the first person to lament the missed opportunity of tackling the Dark Side with a little less regulatory complexity but hey, the robo-advisors are on their way (meanwhile I am available too).

Title IV/Reg A+: Do It Yourself IPO - It is On

Finn: We'll figure it out, we'll use the Force.
Han Solo: That's not how the Force works.

The good news - securities created under Reg A+ allow you to raise up to $50 million from both accredited and non-accredited investors (investment limits apply) and are tradable on the very first day. This means you'll be able to boost your liquidity right away enabling development of an ongoing secondary market.

Another exciting novelty is the so-called "testing the water provision". Remember the Star Wars character Yoda with his prominent slogan, "Do. Or do not. There is no try"?

Well, Yoda's motto is not working in the Reg A+ framework which actually encourages you to try while allowing you to determine the investment interest without pre-reporting to the SEC or the need for a broker.

In other words, during this "testing the water" period you can collect nonbinding interests from perspective investors - and you can do so by utilizing social media or even your own website.

To me, it is pretty clear that the total amount of proposed commitments you would be collecting during "testing the water" will not materialize into the same amount of capital that you will actually raise once you get the SEC approval, but by definition the route is a powerful branding tool.

The key thing to realize is that under the Reg A+ you are entering a highly regulated market opened to the public. This means - you have to get comfortable with a certain level of disclosure as well as incurring costs: $80K-$120K and up.

Keep in mind that the largest and very active player in the new-born market is OTC Group - which has re-defined Market Options for Regulation A+ Companies.

Equity Crowdfunding under Title III: Turn Your Customer Into Your Investor Or Else

Leia: Hope is not lost today... it is found

Title III of the JOBS Act - or what you might call - the "true equity crowdfunding" is on a mission to bring everyone in the private investment game, including non-accredited investors aka crowd. I doubt this option will be as common as we all would like it to be, but it is a good start and have no doubt the engines are on.

Under this rule you will be allowed to raise capital limited to $1 million per year and those securities will have a one-year period before they can be publicly-traded. Companies will need to provide their potential investors with financial statements, but some first-time issuers and those seeking less than $500,000 will not be required to have the statements audited.

The transactions will be performed by FINRA's endorsed intermediaries - funding portals and broker-dealers. An interesting hook is that intermediaries under Title III will be accountable with much higher level of liability than those who are focusing on accredited investors only which I believe will shrink down the new tool from spreading significantly.

Your costs will depend on the size of your offering and I assume would be in the range of $10K-$20K - which is pretty much the average cost associated with raising the angel investors' money.

I believe this route has merit as an additional fundraising tool and it will be especially viable for start-ups with a large social media following, early stage companies focusing on local/niche markets and pre-revenue companies that would collect pre-sale orders in exchange of equity.

I predict there will be a high level of scrutiny coming from the funding portals so the champions will be those with an existing pipeline of (paid) customers which would be a predominating force in building a shareholders base.

Concluding Thoughts: New Era - From Investing to Crowdfinancing

While equity crowdfunding legislation is not picture-perfect, I would like to believe we've stopped the bleeding. Even though equity crowdfunding is not intrinsically good for every company; the absence of such an option is intrinsically bad for the society we are rapidly becoming: free to make its personal financing choices, enamored by technology and - it is time to admit it - completely dependent on the Internet and social media.

To be wired to the public finance and investment possibilities via means of the Internet is a very natural step in the digitalized economy.

To do this cheaply, without using any barrier-builders, underwriters or brokers where your customers could simply download your offering memorandum from your very own website - that's where we can say we've pushed the space-boat out. But this route will be featured in the next Start-Ups Wars episode - let's give it a few more years.

Meanwhile, happy fundraising everyone and, indeed, May the Force be With You.


Victoria Silchenko, Ph.D. is an alternative funding expert, Founder & CEO of business consultancy Metropole Capital Group , Creator and Producer of the Global Alternative Funding Forum and an Adjunct Professor on "Entrepreneurial Finance".
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