No matter who you are, if you want to invest in a publicly traded company it is relatively easy to do so. But what if you want to invest in a private company? Or, what if you’re a startup company needing to raise money but you’ve exhausted your network of friends and family members and you’re unable to raise capital from a bank or from a professional investment fund?
One solution to both of these questions was the Jumpstart Our Business Startups Act (JOBS Act), which was signed into law in 2012. The JOBS Act changed the mechanics and legal structure for how private companies could raise capital from the broader public without having to register with the SEC. In addition, the JOBS Act permitted the use of equity crowdfunding. Per Investor.gov, crowdfunding refers to a financing method in which money is raised through soliciting relatively small investments from a large number of people who may or may not be accredited investors. An accredited investor is anyone who earned income that exceeded $200,000 ($300,000 together with a spouse) in each of the prior two years OR has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
Investing in early-stage companies is risky. Because of this the SEC has placed parameters on how much and how often non-accredited investors can invest into crowdfunded companies, and they also placed parameters on how much and how often private companies can raise capital via this method. Per the SEC definition, as an investor, if either your annual income or your net worth is less than $107,000, then during any 12-month period, you can invest up to the greater of either $2,200 or 5% of the lesser of your annual income or net worth. On the other hand, if both your annual income and your net worth are equal to or more than $107,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $107,000. As a company, the maximum amount you can raise under securities-based crowdfunding is $1.07 million in any 12-month period. If you’re interested in digging deeper into the mechanics of how this all works, click here. But at a high-level, these are the main points.
The reason this is of interest to me is because I believe crowdfunding democratizes the activity of investing in early-stage companies – an activity formerly restricted to the well-connected or to those who met the accredited investor status. For entrepreneurs who live in areas where there is a lower volume of accredited investors, crowdfunding may make a lot of sense. One of the most challenging tasks an entrepreneur faces is raising capital, especially in the early stages when there’s little evidence the company will be successful. However, expanding the investor pool may make the task of fundraising a little less onerous (with the caveat that a company is a legitimate, investable company).
From my perspective, one of the biggest challenges as an investor is sorting through the plethora of companies that are on crowdfunding platforms. Generally speaking, most investors come to know of early-stage companies through network effects where they know the entrepreneur personally or they know someone who does. While having a prior connection to a company doesn’t increase the likelihood that it will succeed, it does help with the problem of selection.
An investment is defined as “the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation of value.” However, in reality, people invest for a variety of different reasons, and money isn’t always the sole motivator. Don’t get me wrong, it’s great to have a positive outcome on an investment. Everyone wants that. But for me, what I like most about crowdfunding is that it provides the opportunity for anyone to invest in a thriving asset class that they were previously restricted from participating in. Crowdfunding also allows companies to expand the universe of potential investors thereby increasing the probability of a successful raise. Even if a company has a successful crowdfunding campaign that doesn’t mean the company will go on to be successful. Investing in early-stage companies is risky no matter where they raise money from. But regardless of whether the company is a success or failure, many companies would have never had the chance to compete if crowdfunding wasn’t an option.
I think the JOBS Act, and more specifically crowdfunding, marked a significant turning point in American finance. While it’s still in its infancy, I think the long-term benefits to the public and to new company formation will be significant.
If you’re interested in listing your startup on a crowdfunding website or you’re an investor (accredited or non-accredited) looking to add early-stage startups to your portfolio, you can review the list of SEC and FINRA approved crowdfunding portals here.
Cheers – KM