Smart entrepreneurs, some Title III crowdfunding skeptics say, do not want hundreds or thousands of unsophisticated angel investors mucking up their capitalization tables, annoying founders with questions, suggestions, job applications, and—gulp—complaints.
In October 2015 the SEC approved final rules for securities crowdfunding under Title III of the Jumpstart Our Business Startups Act of 2012. Title III lets private companies sell up to $1 million in securities per year using online intermediaries known as crowdfunding portals and broker-dealer platforms. This new securities exemption, nicknamed Regulation CF, opens up angel investing to tens of millions of non-accredited investors who have no experience investing in alternative assets. That’s because the opportunities for non-accredited investors to invest in private securities was severely limited by the Securities Act of 1933 and related SEC regulations and court decisions. Title III lets any American invest at least $2,000 per year in Title III offerings, up to $100,000 per year for individuals with high income and net worth. See Step 1 for details (and a worksheet) on calculating your investment limits.
Equity crowdfunding not only invites inexperienced investors to participate, it lets them buy into Title III deals for small amounts—in some cases less than a $1,000 minimum investment, possibly as low as $100. Traditionally angel deals required a minimum of tens or even hundreds of thousands of dollars to buy in. Because of the “democratized” nature of crowdfunding, it is likely that an equity offering will attract hundreds or even thousands of small-dollar-amount investors to most deals.
Not all startups want so many investors, because that, they fear, might clutter up their capitalization tables (spreadsheets that list all the investors along with their shares, classes, percentages, etc.) and create an investor-relations nightmare. Not all startups want a large number of unsophisticated investors, preferring instead a small number of strategic investors (people with specific industry expertise and relationships, for example).
If some kinds of startups do not want to raise capital via Title III crowdfunding for those reasons, what kinds of companies will want to do so? The short answer is: eventually, most kinds. In the short term, though—over the first year or two, starting in spring 2016—a narrower range of companies will have incentives to try raising capital using Title III. Once these pioneers test the waters, and perhaps Congress revises Title III to make the requirements and costs less burdensome for issuers, a broader range of companies will take advantage of Title III crowdfunding to raise capital. One of the proposals in the U.S. House of Representatives, for example, is to let crowdfunding portals pool investor capital into single-purpose funds (SPFs) that invest in a deal as a single entity, most likely an LLC, greatly simplifying the issuer’s cap table and investor relations.
The issuers most likely to benefit from equity crowdfunding in the early days will include the following, among others:
It is possible that high-tech startups which are too small in terms of revenue to qualify for debt financing from commercial banks, and that do not have perceived 10x growth potential (the ability to scale quickly and return 10 times the amount invested within five to seven years) to attract funding from venture capital firms, will turn to Title III for their first round of financing. Investors may be drawn to these issuers by dreams of spectacular returns, or simply because they love gadgets and apps. More on high-tech ventures below.
Some equity crowdfunding skeptics admonish that growth-oriented, high-tech startups will not seek to raise capital via Title III crowdfunding because they need much more than $1 million in seed funding to launch and scale quickly. The cost of launching a high-tech company, however, especially in the software, streaming media, and gaming businesses, has dropped precipitously in the last decade, thanks in part to:
If launching a high-tech venture required $5 million in funding 10 years ago, it can be done today for $500,000 or in some cases as little as $50,000, which are well within the equity crowdfunding ball park. This steep drop in entry-level capital is already leading to a “tidal wave” of new entrepreneurs, says Wharton School management professor Raffi Amit.
Keep in mind that companies are not limited to one round of equity crowdfunding. Many startups may seek to stage their fundraising into annual rounds of $1 million, which is permitted by the rules, or blend crowdfunding with other methods of equity or debt financing. Some conventional lenders, for example, are looking into new programs that would match a line of credit to the amount a company could raise through Title III.
David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…
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