Hundreds of days past the deadline, an SEC panel today unanimously voted to propose a rule allowing equity crowdfunding of startups by anyone, not just rich accredited investors. The rule will now go into a lengthy public comment period before an SEC vote on whether it will go into effect.
True crowdfunding is the third piece of the JOBS Act to be addressed by the SEC. It approved lighter reporting requirements for startups earlier this year, and just last month lifted the longstanding ban on general solicitation of fundraising by startups and investment funds.
First, companies can only raise up to $1 million a year from the crowd. There are limits on the percentage of their income a person earning less than $200,000 a year can invest. For example, someone earning less than $100,000 a year can only invest $2,000, or 5% of their income. The current proposal doesn’t require companies to verify the income levels of its crowd investors. However, this is a topic the SEC wants to see the public discuss during the comment period.
According to Crowd Funding Forum, the amount an individual can invest will be based on either their net worth or income level bracket, whichever is higher. Deals will have to go through registered crowdfunding portals like startup CircleUp. Non U.S. crowdfunding portals can submit to an on site examination by the SEC if they want to register to manage equity crowdfunding. Companies will need to keep accurate lists of their investors, which may be aided by hiring a registered transfer agent.
If equity crowdfunding by unaccredited investors is eventually passed, it could unlock a huge well of funding for startups.
Traditionally, startups raise from expert angel investors in their domain or established venture capital firms that provide guidance, connections, recruiting help, and other services along with their money. Crowdfunding could be used to augment standard VC with an army of smaller investors that could be evangelists and testers, but also help with connections and recruiting like a big firm.
Some criticize crowdfunding as “dumb money” that’s less valuable than the better VCs. It’s true that top startups with the clout to raise from prestigious, high value-add firms might be better sticking to the traditional route. But filling in part of a funding round with the crowd could still be helpful to get a wide base of support. And for second-tier startups that often raise from VCs that don’t provide much extra help and often can’t return their funds, the crowd could be a good option.
Crowdfunding may pose some dangers to mom-and-pop investors. That’s why the limits are in place. But really, the biggest threat of crowdfunding may be to worst of the venture capitalists. If the rule passes, startups won’t be forced to beg them for money any more. Thanks to a combo of general solicitation and unaccredited investor crowdfunding, they’ll be able to ask everyone to fund their vision.
Below is the full text of the rule proposed by the SEC: