In October, the Security and Exchange Commission unanimously approved a set of rules proposed by the JOBS Act of 2012 meant to regulate crowdfunding. This long-awaited decision finally sanctions crowdfunding, which sites like Kickstarter or Indiegogo have proven to be a legitimate source of startup capital, as an acceptable investment vehicle. It also means that, theoretically, small businesses have another possible source of funding, outside of the traditional banker, venture capital firm or angel investor. But will these rules actually make it easier for startups to raise capital? Or will they create a muddle of government regulations that no small business owner in their right mind will want to deal with?
It Widens the Investor Pool...
Expanding the number of eligible investors will certainly be a boon to small businesses looking to raise capital. Currently, anyone that makes less than $200,000 a year, or holds less than $1 million in assets, is a "non-accredited investor." Businesses can only seek funding from a maximum of 35 unaccredited investors, which makes raising capital through crowdfunding very difficult. Thanks to these new rules, nearly anyone, regardless of their income, can invest without limiting how many investors the business can take on. However, crowdfunding is capped at five percent of annual income for those with incomes of less than $100,000, and at 10 percent of for annual incomes of more than $100,000. Still, even with this cap, removing the "non-accredited investor" status from those looking to support startups will help new businesses looking for crowdfunding.
But Comes With a Cost
While it is great that these changes allow for an entirely different type of investor, small businesses looking to raise money through crowdfunding will have to comply with some hefty regulations. The SEC has estimated it will cost about $6,000 to prepare and file the form required for the initial offering, and about $4,000 a year to comply with annual reporting requirements.
Small businesses that use crowdfunding are also required to disclose information about the owners, directors and officers of the company, and must furnish a professionally audited or reviewed copy of the company's tax returns. By the SEC's own admission, these reports will cost quite a bit of money, which could initially scare small businesses away from crowdfunding, especially if the intermediaries charge a hefty fee for connecting investor and business.
Though It Also Promotes Competition Between Funding Platforms
Crowdfunding is restricted to the internet, and investments have to be raised through an intermediary. This online intermediary can either be a registered broker or a new entity called a "funding portal," though in both cases the intermediary must be a FINRA member. The SEC estimates that 50 portals will initially participate in the market after the new rules are adopted, and that means there will be serious competition between these funding portals. And that competition is good news for start-ups looking to avoid paying ridiculously high intermediary fees. So, while reporting may cost an arm and a leg, at least the costs of using the required intermediary could be lower.
These rules are a bit of a mixed bag, but I believe they will benefit small businesses in the long run. Reporting costs will go down as forms are standardized, and competition will keep intermediary fees lower. By approving these rules, the SEC is empowering the average person to help fund the small businesses that they believe in, and gives ideas deemed too risky by traditional sources of capital another chance to make it to the market. The SEC will finalize equity crowdfunding sometime in February 2014, after a 90-day period, during which the public can comment on the proposed rules, and analysts are hoping funding portals will be up and running by the third quarter of 2014. Once the floodgates are opened, I believe we will begin a real revolution in small business investing.