The Securities and Exchange Commission voted to implement Title III of the Jumpstart Our Business Startups (JOBS) Act on Friday. Translation: It’s now legal for ordinary Americans to invest in startups and small businesses.
Unlike Kickstarter or GoFundMe, which allow you to invest in a product or idea like Spike Lee’s latest movie, the Keyboard Waffle Iron or potato salad and would in return get a token gift (or some potato salad), equity crowdfunding actually allows you to own a stake of the business. This could mean huge potential profits if the business succeeds or goes public; however, it could also result in steep losses.
Until now, you had to be an “accredited investor” to have equity in a private company. There are two ways to qualify -- and either way you have to be wealthy. Your income has to be at least $200,000 (or a combined $300,000 for married couples) in each of the prior two years. Second, eligible investors must have a net worth of over $1 million, either alone or together with a spouse (excluding the value of his or her primary residence).
A slow process
President Obama signed the JOBS Act into law in April 2012 and since then it’s been implemented gradually. It was created to encourage small business and startup funding by easing several federal regulations. The first part of the JOBS Act, or Title I, provides “emerging growth companies” (those with less than $1 billion in revenues over the past fiscal year) partial exemption from certain disclosures that might deter them from going public.
In 2013, Title II of the JOBS Act legalized raising investment funding publicly. Before that, early stage companies were prohibited from publicly advertising that they were seeking investment on sites like Facebook and Twitter.
Title III has been the most problematic point for the SEC -- primarily because it opens up average Americans to the private investing world -- and is one reason that part of the law has languished for the past three-and-a-half years. Of the four SEC commissioners, only one, Michael Piwowar, dissented in Friday’s ruling: “I fear that many traps for the unwary are hidden in the regulations, creating potential nightmares for small businesses and their owners who fail to place regulatory compliance at the top of their business plans. Such burdens will spook many small businesses from pursuing crowdfunding as a viable path to raising capital.”
Despite potential regulatory obstacles, Ryan Feit, the CEO of SeedInvest, an equity crowdfunding platform, told Yahoo Finance that there has been significant pent-up demand to invest in startups and small businesses.
SeedInvest polled 18,000 non-accredited investors and found that 68% are likely to invest in startups when the laws change and 75% expect to invest at least $1,000 per company.
Feit acknowledged that there are several risks that come along with the ruling. “Unlike a public stock you can’t necessarily trade your shares, so you’re investing for a longer term -- three to five years,” he said. “And you should only really put no more than 10% of your overall portfolio into private companies. I think this is a great thing, but we have to do it with caution.”
Limiting risk for investors
The SEC has implemented caps for investors depending on income. If your income is $100,000 or less, you’re allowed to invest up to 5% of your income. Those earning more than $100,000 can invest up to $10,000.
“You can never make investing risk-free, but the SEC maximized transparency requirements. [Title III] is absolutely necessary for small businesses to expand and actually find responsible avenues to access capital,” said John Arensmeyer, CEO of advocacy organization Small Business Majority.
Both Arensmeyer and Eliran Sapir, co-founder and CEO of Mark Cuban-backed market intelligence company Apptopia called the SEC decision “game-changing.”
Sapir told Yahoo Finance that this is the first time that customers can truly “get in on the action.” Whereas entrepreneurs have to perfect their pitches to venture capitalists, this new avenue of funding allows consumers to invest in a company that they already know and love. Perhaps this will allow startups to be less dependent on VC funding in the future.
He also noted that individuals do have a lot more at stake, compared to institutional investors like VC firms. “New technology is bound to fail. But VCs have the capacity to take a loss. Entrepreneurs have scammed investors before. A small investor without as many resources has no ability to protect himself.”
It will take 90 days for Title III to be implemented, so starting in January anyone will be able to invest in their favorite pizza joint or new app (but only if the company is seeking funding).
Sapir echoed that many individuals are excited about the democratization of crowdfunding.
“Consistently, we’ve had many of our users reach out saying, ‘I would like to invest.’ Every time there’s news about funding we’ve received, the company gets five to 10 emails from people asking how they can invest.”