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Oct 07

What is the Status with Equity Crowdfunding?

  • October 7, 2016
  • News

In the early stages of turning an idea into a reality, crowdfunding platforms like Kickstarter and Indiegogo have provided startup companies with the means to establish capital that wouldn’t otherwise exist. A series of small contributions made from a large number of people, crowdfunding serves as an alternative to traditional financing for a generation of startups that are anything but traditional.

Over 10 million people from around the world have at one point donated to a Kickstarter campaign. Naturally, the modern startup landscape lends a perfect stage for crowdfunding to come in all shapes and sizes. Most popular are donation-based, rewards-based and presale campaigns. Up to this point, the flexibility of these different types of campaigns deems them a logical choice for entrepreneurs to utilize in the fragile beginning stages of their business.

A donation campaign offers nothing in exchange for funds, it simply offers an outlet for anyone to fuel a project he or she believes in and wishes to see come to fruition. Reward-based campaigns provide backers with some type of incentive defined by the business in advance. This can come in the form of free branded product or even the right to vote on aspects of the product. A presale campaign raises funds for a product before that product even physically exists.

Each of these options has proven successful for inventors to raise money without drowning in liabilities and limitations. In addition, these campaigns can grant the developer previews of the market they are attempting to break into, their targeted audience and a legitimate platform to begin promoting their idea to the public.

A brand new type of crowdfunding was launched in May 2016. Equity Crowdfunding, through a registered broker dealer, made legal by the Jumpstart Our Business Startups or the JOBS Act passed by Congress in 2012, was pending implementation until just a few months ago. Rather than the campaign types listed above, this version of fundraising is not donation driven. Instead, equity crowdfunding broadens the criteria of investors to welcome a larger pool of people who are willing to make monetary contributions to startups. Now almost anyone can permeate the market free of the restraints required to become what was once considered an accredited investor.

Before Title III of the JOBS act became active, companies were only able to accept money in the form of capital from whom the Securities Act of 1933 defined as an accredited investor. Such investors must earn at least $200,000 per year for two years, have an annual joint income of $300,000 for two years or hold a net worth of $1 million.

The JOBS act has now made it possible for a person, who earns an average income, to purchase a small equity stake in startups. Equally groundbreaking, Title III even allows for these securities-based crowdfunding transactions to occur online.

The stipulations of the law require that a potential investor must go through an official brokered-dealer to legally purchase shares. All funding portals and intermediaries must be registered with the Securities and Exchange Commission (SEC) to ensure their compliance with multiple regulations while also acting as a gatekeeper against potential fraud.

The maximum amount such investors can invest is capped at $100,000 per year. Also, if the annual income or net worth of the investor is less than $100,000, he or she is limited to investing the greater of $2,000 or 5 percent of their annual income or net worth. If the investor’s annual income and net worth is equal to or exceeding $100,000 the amount invested cannot be more than 10 percent of their annual income or net worth.

In an effort to educate those who wish to be apart of this process, equity crowdfunding platforms must also provide information to both investors and issuers upfront, continuing to guide both parties throughout the entire transaction. According to the SEC, all funding portals are required to become members of a registered national securities association and today the Financial Industry Regulatory Authority (FINRA) is the only such association that exists. According to Crowdfund Capital Advisors, WeFunder and Start Engine are two of the most widely used platforms at this time, holding the highest percentages of offerings out of all registered FINRA platforms. A list of all current FINRA funding portal members can be found here.

At the top of the list with 38.6% of contributions since May 16, 2016, WeFunder’s website headline reads, “Break the Monopoly of the Rich” referencing the end to a government-protected investor’s market for high-growth startups. The company Beta Bionics, makers of a stand-alone device that automatically controls blood sugar, currently leads all equity crowdfunding campaigns in funds raised with over $1 million invested through WeFunder. To date, $8.5 million of total capital has been committed through regulated equity crowdfunding; not going gangbusters quite yet, but this amount is increasing at a steady rate.

In just a few short months, statistics like these raise a lot of questions about equity crowdfunding and if it is in fact the right choice for startups or investors. Research conducted by Crowdfund Capital Advisors shows that campaign capital flow is the most lucrative in the Entertainment (Media) and the Technology (Hardware) sectors.

From the investor’s perspective, the risks involved with purchasing equity through a regulated funding platform resemble those of any perk-based crowdfunding campaign.

In its early beginnings, equity crowdfunding is shredding apart the highly exclusive realm of investing. Still not even close to widespread adoption, in its first year of regulation, most equity crowdfunding activity has occurred in the state of California. Whether you are a curious investor looking to provide resources to the high-growth startup market or an entrepreneur looking to raise funds in creative ways, raising and donating capital through equity crowdfunding is on the rise and an option worth looking into.

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