Get the PayPal account ready.
Startups can now raise up to $50 million by selling stock online to anyone, opening the door for Internet-based equity crowdfunding platforms to begin operation.
The Securities and Exchange Commission voted unanimously on Wednesday to adopt rules that permit startups to raise money from the vast majority of Americans, including provisions that allow for deals to be made over the Internet.
Previously, only individuals with more than $1 million in net worth or income of at least $200,000 for each of the last two years — so called “accredited investors” — could easily invest in startups. Some websites already offer the chance to invest in startups online, but prospective investors had to be accredited and subject to more stringent regulations.
Just how many people might be interested in dropping money on a startup is the subject of some debate, but the World Bank projects that the worldwide equity crowdfunding market will hit $93 billion by 2025. Crowdfunding investment platforms are now active in countries around the world.
Putting 10% of your net worth on the line — with a few barriers
Under the changes, startups would be able to raise up to $50 million in a year through equity, debt or convertible debt-to-equity arrangements from the public, including through online platforms. All individuals are now free to participate but can only invest up to 10% of their net worth.
The changes don’t entirely open the floodgates to allow consumers to pour their bank accounts into the first startup they see. Stock offerings open to crowdfunding will still need to be “qualified” by the SEC, a simpler step than an officially registered offering like an IPO — but one that still requires legal help, according to Sara Hanks of CrowdCheck.
Online equity platforms will still need to be registered with the SEC as “broker-dealers,” which means they will be regulated financial institutions authorized to be middlemen in the buying and selling of stocks, bonds and other securities.
The trouble with touting new investments on Snapchat
There are also limitations about how startups can solicit for investments, particularly on social media. Startups are also not mandated to create a system in which potential investors share information and commentary among themselves, and face challenges in setting up a system to do so.
The vote also bodes well for the future adoption of additional rules meant to allow for equity crowdfunding at smaller levels.
So we are to expect further expansion of exemptions from #sec registration for small offerings? Yay!
— Sara Hanks (@SaraCrowdCheck) March 25, 2015
The vote is a major step toward fulfilling one of the two equity crowdfunding mandates of the JOBS Act, which U.S. President Barack Obama signed into law in April 2012. More details are yet to be worked out by the SEC with respect to equity crowdfunding and the JOBS Act, which are expected to be voted on later this year.
Potential risks for consumers, including the infamous ‘tech bubble’
The proposition of allowing the general public to buy into startups has been a divisive idea. Proponents argue that the laws surrounding who is allowed to invest are antiquated — the primary law dates back to 1933 — and that the risk of fraud is far lower. Critics say that uninformed people will be unaware of the risks involved in startup investing and will be susceptible to scams.
Startup investing is undeniably risky. While there is little in the way of concrete data about success rates, the chances of investing in a startup that breaks even — let alone becomes a runaway success — are generally regarded as being very low. One study found that 75% of startups fail, while even the best venture capital firms tend to completely miss on a third of their investments.
There is also concern about the broader impact of the possible influx of cash from equity crowdfunding.
Growing concerns about inflated valuations of startups have led some, like investor Mark Cuban, to argue that tech is experiencing a bubble — in which prices rise quickly before falling just as fast.
In a blog post, Cuban pointed to the rise of equity crowdfunding as one of the causes of the current bubble. He argued that inexperienced investors have pumped money into the startup market, but have no way to get it out.
Crowdfunding also has its supporters, including AOL co-founder Steve Case, who recently said that he agreed some valuations have become “excessive,” but argued that equity crowdfunding has a positive impact beyond opening up a new pool of investment capital.
“Even when these ‘investments’ don’t ‘pay off’ for the person making them, they make the community a better place, and create winners in unexpected ways,” Case wrote.
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