Entrepreneurs who have been chomping at the bit to launch equity crowdfunding campaigns since President Obama signed the JOBS Act into law in April 2012 should regard news of a Securities and Exchange Commission vote on the subject today with measured optimism. Yes, the agency agreed on a proposal (pdf) outlining how private ventures can use the online fundraising model to sell shares to individual investors. No, the final rules won’t likely take effect for a while.
That’s a good thing. To be successful, the rules need to make crowdfunding useful to businesses hoping to raise money, while preventing investors from chasing the crowdfunding craze all the way to financial ruin. For 80 years, private companies selling shares have had to limit themselves to raising money from accredited investors—people who are assumed to be wealthy enough to weather losses and sophisticated enough to know what they’re getting into. Equity crowdfunding will let anyone buy shares in a private offering, regardless of his or her wealth. It’s no wonder the framework of rules the SEC published today runs 585 pages (pdf).
One proposed protection: limiting the amounts investors can put into a crowdfunding campaign to between $2,000 and $100,000, depending on annual income or net worth. That’s important, not just to protect investors from getting ripped off, but also because investing in startups is hard, even for the pros. Notably, today’s proposal doesn’t count the value of an investor’s primary residence toward net worth threshholds. “No senior citizen living off of a modest, fixed income should be at risk of losing her home to a crowdfunding venture,” says Commissioner Kara Stein in her prepared comment.
There are other precautions. Companies can’t crowdfund more than $1 million in a given year. Companies that raise more than $500,000 will have to undergo annual audits and file financial statements with the SEC, according to Rory Eakin, chief operating officer at startup fundraising website CircleUp. He says those provisions are problematic, because they’ll cost startups money and may allow previously private information to become public.
That’s likely to discourage the best startups from using crowdfunding to sell shares, says Eakin. “The dialogue has been too heavily on fraud and fraud prevention,” he says, emphasizing that it remains an important goal. “Long-term, strong risk-adjusted returns is the bigger issue.” In other words, if promising startups don’t use equity crowdfunding, serious investors will also stay away, undermining the intent of the JOBS Act to make it easier for startups to raise money.
Of course, that’s just one interpretation. There will be time for plenty of others. Once the framework released today is published in the Federal Register, the public will have 90 days to comment, after which the SEC will set to work on finalizing rules. For context, the agency first proposed new rules governing general solicitation, another closely watched aspect of the JOBS Act, in August 2012. Those rules didn’t take effect until last month.