A Brave New Crowd: What the New SEC Action on Crowdfunding Could Mean for Entrepreneurs

by youngro lee

Love for Crowdfunding

(This entry is the first of a two-part series on the NextSeed Blog, breaking down the recent SEC action regarding investment crowdfunding. Part 1 seeks to analyze the impact of these legal developments from a business’s point of view. Part 2 will cover the potential implications of the new crowdfunding rules from the investor’s perspective.)

Last Friday (October 30th), the US Securities and Exchange Commission voted to finalize Title III of the JOBS Act, which will generally permit any company to raise capital online from any investor.

(This is not to be confused with reward-based crowdfunding – e.g., Kickstarter. We are talking about the ability to sell financial securities in private businesses via SEC-registered crowdfunding platforms.)

Why is this a big deal?

Until now, only those individuals with a net worth greater than $1 million or earning over $200k annually were permitted to invest in private companies (whether businesses always complied with this restriction is a separate matter, of course). Although it took more than 3.5 years for the SEC to finalize these rules since the JOBS Act originally passed in 2012, last Friday’s SEC action marks a fundamental shift in the principles behind US securities laws and reverses nearly 85 years of precedent.

You can read the actual rules here, but it’s 686 pages of legalese. For now I’d recommend reviewing these fairly good summaries of the rules here and here to give yourself a quick overview. If you are REALLY interested in learning the details, in just a couple weeks countless prestigious law firms around the country will produce excellent legal memos and summaries about these rules. Besides, there’s no need to rush anything – these rules won’t become effective for another 180 days, so you have some time to think carefully about your next steps. In this blog entry, I wanted focus on what has NOT been covered, and highlight a few critical issues to help you think about whether investment crowdfunding is right for your company.

First, you’ll notice that the vast majority of national press (including the New York Times and Forbes) has been quick to announce the legalization of “equity crowdfunding.” In today’s unicorn-loving, clickbait-chasing media-speak, the storylines generally imply that only tech startups will benefit. Certainly, the new rules provide an alternative process for tech startups to raise capital that could be extremely effective in certain contexts. However, it’s critical to understand that despite what the headlines say, the new rules are not for “equity crowdfunding” but rather for “investment crowdfunding” – meaning you can actually sell any type of securities, including debt, hybrid or any other type of financial securities that makes sense for your business.

After all, if you really think you have something special on your hands, you should actually fight to hold onto as much of your equity for as long as you can (Bill Gates still owned 45% of Microsoft when it went public).  Too often, entrepreneurs feel that it’s prestigious to raise capital from “angels” and “venture capitalists” without really understanding the price of that prestige and certainly not all the nuances of fundraising. More importantly, the crowdfunding rules were never designed just for tech startups – they were meant to help ALL businesses (whether you own a hair salon, healthcare practice, restaurant or bar) access a new avenue for capital rather than having to rely on traditional financing sources.

In sum, given last Friday’s events, it is very important to understand that crowdfunding is not only a new fundraising option, but an entirely new way of doing business. So if you’re thinking about whether or how to pursue crowdfunding for your company, ask yourself these key questions:

  1. Is it beneficial for your business to have a large number of people financially and emotionally vested in its success and for these people to potentially become actual customers of your business (bars, restaurants, consumer packaged goods, fitness centers, etc.)? If so, it may be helpful to try to get as many investors as possible via crowdfunding versus getting a small number of investors in a private placement or seeking loans from financial institutions.
  2. Do you consider your business a “local” business that is dependent on local customer base (e.g., neighborhood coffee shop or pizza joint), or are you a “national” business (e.g., sell ice cream through grocers nationwide)? Depending on where your network resides and where you would like to attract new customers, certain intrastate or federal crowdfunding rules could be more suitable.
  3. Are you comfortable with disclosing your financials to the public and being completely transparent with your investors? If not, crowdfunding will not be an attractive option to you.

There’s a brave new crowd out there, eagerly awaiting the opportunity to support and invest in entrepreneurs they believe in. Nothing’s easy of course, and there will surely be bumps along the way for all participants in the burgeoning crowdfunding industry. However, with the right preparation and right partners, you may be able to leverage crowdfunding to take your company to the next level, and bring the crowd along with you for the ride!