[Corrected 11/2/15, 12:30 pm. See below.] Mom and Pop, you can now buy shares in the bakery down the street, or in your son’s girlfriend’s sister’s tech startup. That, in effect, was the message the U.S. Securities and Exchange Commission sent today, voting to give retail investors the right to buy shares in tiny private startups through so-called crowdfunding mechanisms.
Crowdfunding, until now, has mainly helped small U.S. companies and individuals such as filmmakers and inventors raise cash through donations. A legion of websites, such as Kickstarter, Indiegogo, Experiment, RocketHub, and others, have hosted a vibrant exchange between fledgling companies and their well-wishers. Not many companies that reaped seed money from crowdsourced donations have gone on to raise institutional venture capital. One example is the citizen science firm uBiome.
Crowdsourced fundraising has also generated some controversy. Glowing Plant, which accepted funds on Kickstarter in exchange for engineered seeds that grow into, yes, glowing houseplants, sparked an uproar over its spread of genetically modified organisms.
The new crowdfunding rules, approved today by SEC commissioners 3 to 1, now make clear what has been somewhat murky: How tiny startups will be able to offer, not just small thank-you gifts to contributors like seeds or T-shirts, but equity to crowdsourced investors. It was the final piece of the law known as the JOBS Act—Jumpstart Our Business Startups—to fall into place.
President Obama signed the JOBS Act into law in 2012, and it is widely considered a major catalyst for the three-year IPO boom that followed, thanks to its looser restrictions on taking companies public—the “IPO on-ramp” part of the bill.
The JOBS Act also outlined a path forward for equity crowdfunding, with some rules such as a $1 million cap per year on any single company’s crowdfunding effort. But the SEC has been slow and deliberate—maddeningly so, to its critics—in making changes or creating more specific regulations, wanting to balance the needs of cash-hungry startups against the protection of so-called mom-and-pop investors who might see their life savings wiped out by bad bets.
Thanking her staff for its work, SEC chair Mary Jo White this morning called the effort “extraordinarily complex rulemaking.”
“The SEC has done a nice job balancing adequate controls with nimbleness,” said Tobin Arthur, CEO of funding portal AngelMD, which has forged ahead with the crowdfunding of healthcare companies for a more specialized set of investors.
To those following the long process—more than three years since President Obama signed the JOBS Act, and two years since the SEC first drafted the proposed crowdfunding rules—much of what the SEC greenlighted today was not a surprise.
For example, the JOBS Act language put a $1 million cap on the amount a company can raise within 12 months. It also placed a limit on what an investor can bet, based on his or her income and net worth, from a minimum investment of $2,000 up to a maximum of $100,000. Those caps did not change today, and they might constrain what kinds of startups seek crowdfunded cash in the future.
But there were surprises. The biggest, perhaps, was that first-time issuers will not have to prepare their financial records for a formal audit. “There was no hint of this exemption,” said Morrison & Foerster attorney Anna Pinedo. “It’s a very constructive change. I know companies were worried about the cost, and many companies thinking about crowdfunding are going to be new to the realm of SEC disclosures and filings.”
Two types of companies will be permitted to facilitate “securities-based” crowdfunding by introducing companies to potential investors online, and both will have to register with the SEC. The first category is conventional broker-dealers, and the second is a new class of SEC registrant called a funding portal.
Both will be subject to oversight, just as in traditional investment situations. Some responsibility for vetting the companies making securities offerings will fall upon the portals, although those portals will also be allowed to take equity in the companies they list as compensation for their work—as long as they receive shares under the same terms as everyone else buying the shares.
That responsibility could end up being a marketing tool, as the number of platforms vying for investors expands. “Oh my gosh, there’s going to be so much competition,” said Bill Clark, CEO of Austin, TX-based MicroVentures. “We’ll really have to tout our track record more and then really explain to people: there’s a big difference between us and a platform that will list any company.”
The SEC rules will go into effect 180 days after they are published in the Federal Register, and portals will be able to register with the SEC on January 29, 2016. It should not take long for competitors to throw their hats in the ring. In a written statement today, Indiegogo CEO Slava Rubin said, in part, “We’re now exploring how equity crowdfunding may play a role in Indiegogo’s business model.” [This paragraph was updated with the correct timeline for the SEC rules.]
Indiegogo has been advocating for equity crowdfunding for years, starting before the JOBS Act was passed in 2012. The founders of San Francisco-based
