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Crowdfunding has become an important tool for startups that want to raise new capital. While popular platforms such as Kickstarter and Indiegogo have helped entrepreneurs launch successful businesses for years, new U.S. regulations are now helping startups take this revolutionary capital-formation tool to the next level.
A new crowdfunding regulation stemming from the Jumpstart Our Business Startups Act, or JOBS Act, is making it possible for startups to raise capital online from a wider net of investors. Originally signed into law by President Obama in 2012, the law was intended to help small businesses grow by making it easier for them to raise money.
“It’s been transformative,” said Richard Swart, chief strategy officer of NextGen Crowdfunding, a company that helps entrepreneurs raise money online. “It allows entrepreneurs to keep more control over their businesses, set better terms for crowdfunding, and deepen relationships with their investors.”
Previously, only a select group of investors that met a certain wealth threshold—an income of at least a $200,000 or a net worth greater than $1 million—could invest in early-stage startups. These investors were known as accredited investors.
Conversely, individuals with more modest incomes could only invest via crowdfunding platforms that didn’t offer potential equity return. Instead, they might receive advance prototypes or early products such as branded coffee mugs, but they did not receive an equity share in the company, as accredited investors did. This, while amateur investors would not be exposed to potential drops in a company’s value, they also would not share in any potential gains if the startup’s worth increased.
The crowdfunding provisions in the JOBS Act have opened up a new world for entrepreneurs, said Scott E. McIntyre, who is on the board of directors for the non-profit Crowdfunding Professional Association. He explained that many early-stage companies lack sufficient collateral for bank loans and are too small to attract larger investors or funds.
“Previously an entrepreneur needed a rich uncle, a big family or access to professional investors,” he explained. “The new rules are both vital to capitalizing small businesses and bringing the opportunity to invest in early-stage ventures to all citizens.”
Here are what investors, startup founders and small business owners need to know about the new regulations:
1. Anyone can be an investor
There are no requirements or prerequisites for investors. Anyone over the age of 18 can buy a stake in a U.S. startup.
2. It’s completely legal and approved by the Securities and Exchange Commission (SEC)
Startups and small businesses can sell shares through crowdfunding websites or brokers registered with the SEC and Financial Industry Regulatory Authority (FINRA).
To start crowdfunding their businesses, entrepreneurs first need to register the sale with the SEC. They also need to provide basic information about company stakeholders, the nature of the business, the target offering amount, and the financial condition of the company. Firms will also have to disclose risk factors associated with their business or industry, among others.
Once companies accrue $25 million in assets or exceed 500 unaccredited shareholders they must also begin regularly filing disclosure reports, similar to publicly traded companies.
3. Crowdfunding has its limits
Of course, there are limitations to how much money investors can contribute to any startup or small business. For example, individuals with an annual income of $150,000 or a net worth of $100,000 can invest up to 10 percent of their annual earnings.
Here’s a look at the SEC’s new investment limitations:
Courtesy of the Securities and Exchange Commission (SEC)
Altogether, companies can raise up to $1 million from investors over a 12-month period. That may not sound like much considering the multi-million dollar fundraising rounds that often make news in the tech world, but the funding can be critical for entrepreneurs who are just starting out.
4. Be careful
While many entrepreneurs are happy that the long-awaited rules have finally come into effect, some in the investment community are wary about how amateur investors will fare in the crowdfunding world. After all, it can take years for startups to turn a profit, and the risks for new businesses are high.
Bottom line: experts are advising both investors and entrepreneurs to do their homework before jumping into equity crowdfunding head first.