SEC Greenlights One Style Of Equity Crowdfunding For Startups

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The SEC today paved the way for a new era of venture capital investing by stating it won’t pursue enforcement action against FundersClub, whose platform lets any accredited investor fund startups in exchange for equity. Before, some thought FundersClub’s founders could face jail time for violating finance laws. FundersClub’s model could be used by others to raise capital online for startups before the JOBS Act goes fully into effect.

FundersClub is a Y Combinator-incubated startup that has raised $7 million to build its online venture capital system. Its website hosts profiles of different startups looking to raise money. Any accredited investor (someone who earns over $200,000 a year or has a net worth over $1 million) can choose to invest as little as $1,000 in startups with open rounds on FundersClub. These investors can cash out if the startup is acquired or IPOs, or if they do a stock offering on the secondary market, and FundersClub gets a cut of the money.

fundersclub-big-logoHowever, FundersClub was thought to be operating in a murky legal grey area because it’s not a registered broker-dealer. FundersClub maintained its innocence, saying it never directly handles the invested money, which is kept in separate custodial accounts for each startup it hosts. Technically, it’s not crowdfunding, but rather a venture capital advisor that raises funds online through a streamlined process rather than offline with traditional paperwork.

Now the SEC has issued it a “No-Action” letter, vindicating FundersClub. The SEC statement explains “The Staff will not recommend enforcement action to the Commission under Section 15(a)(l) of the Exchange Act if FundersClub and FC Management engage in the proposed activities described in your letter”, referring to a plea from FundersClub outlining how it operates.

FundersClub CEO Alex Mittal tells me:

“The letter is a win for accredited investors, startups, and the VC industry, and strong validation of the business model of FundersClub–to bring the transformational impact of the Internet to venture capital.

It allows FundersClub to do something online that historically venture capital advisers have only done offline. Via the no-action letter, the SEC has officially recognized the legitimacy of online VC, a field we’ve pioneered and are leading with FundersClub.

For accredited investors, they are now allowed much more flexibility in how they invest in venture funds that support start-up companies. For startups, they are gaining easier access to an important source of capital and value-add.”

The letter creates a roadmap to legal online fundraising for startups that other platforms could employ. There’s also the alternative route to legal online VC where operators become standard broker-dealers, which is the approach taken by newer YC startup WeFunder.

The SEC’s decision could make it easier for startups to get funding from large swaths of independent investors, rather than a small group of angels or VC firms. With crowd backing comes an army of evangelists, marketers, recruiters, and business development assistance. It could be an appealing complement to old school venture capital that comes with mentorship and insider connections.

Later this year, the JOBS Act is expected to go fully into effect, allowing non-accredditted investors to back startups in exchange for equity, and startups to publicly promote that they’re raising money. But until then, online fundraising by accredited investors just got a critical thumbs up from the regulatory body that could have shut it down.

You can read the full “No-Action” letter from the SEC to FundersClub here:

Update: This article has been edited to clarify the difference between standard equity crowdfunding, and FundersClub’s online venture capital model.

[Image Credit: Shutterstock / Helder Almeida]