Last month something big happened in the crowdfunding world. Three long years after the passing of the Jobs Act, non-accredited individuals can finally invest in private companies. This is going to be the first time since the Great Depression that an average American can do this. The new rules, called “Reg A+” will replace the former “Reg A” rules which were barely used in the financial world. The major changes are the following:
1. Increase how much a company can raise from $5 million to $50 million.
2. Allow non-accredited investors to invest up to 10% of their income or net worth per year.
3. If the company is raising less than $20 million, then it doesn’t need to do audited financing statements, or register in every state.
It’s going to take some time for companies to start using the new rules but this will change the financial industry as we know it.
WHY THIS WILL CHANGE INVESTING
Currently only accredited investors such as angel investors or VCs can invest in private companies. To be accredited, a person needs to make over $200,000 income or have net worth over $1 million. It is estimated that only eight percent of the population of the US is accredited. Since accredited investors mainly invest to make money, they focus on companies that are likely to make an exit—either be sold, or go public. Until now, this has amounted to less than 1% of all businesses in the US receiving investment money.
Now, with the new rules, the rest of the population will be able to invest in these non-public companies. This is big news for startups and small businesses because it allows the other 99% of businesses to receive funding in exchange for ownership/equity in the company.
This is where equity crowdfunding really comes into its own. Though it has been around for several years, these new regulations will really allow equity crowdfunding to take off. Much like traditional crowdfunding, equity crowdfunding allows for the raising of money online from individuals; however, instead of a rewards system—where a product or service is offered in exchange for the funding—equity crowdfunding offers investors shares of ownership of the company.
BE AN EDUCATED INVESTOR
On average, these businesses won’t have the same exit opportunities, which would mean their investors will most likely not make a return. The majority of small businesses in the US are lifestyle companies and don’t have exit opportunities. Now that anyone can invest in these companies, it’s very important to educate these new, non-accredited investors about the risks of equity crowdfunding. They must not think that they will hit the next Facebook or Google. Investing in private companies is extremely risky and non-liquid.
So, why would any person give their hard earned cash to a business? I believe that investments in these type of business, like a local diner for example, will be driven by the community and customers who want to keep the business running and believe in it beyond the financial incentive. Helping the business should be first on the list of reasons for investing; becoming rich should be second. As part-owner of a local business, investors can receive special perks or dividends from the company. This can also be a big change for businesses with a good cause, such as green technology. In the past, these companies had to be non-profits to take donations; with the new rules they can be for-profit businesses while taking money from individuals. People who are passionate about their cause can contribute and become part owners. This will be a huge shift in the traditional funding paradigm that will change how small businesses raise money.
WHAT IT MEANS FOR BUSINESSES
Before businesses get excited about equity crowdfunding they need to figure out if equity crowdfunding is the best way for them to raise funding. If the business needs the money very fast, under a week, they should use debt online funding. Equity crowdfunding can take months to put together and can cost a lot of money for incorporating, legal fees, and audited financing if they are raising over $20M. Reward crowdfunding doesn’t have any of those starting costs, and might be a better option if the company is low on cash.
If equity crowdfunding is the best way to raise money, the business needs to understand who the investors are, how to market to them, and what to offer them for their money. If they are targeting accredited investors they will need to prove that they will have an exit opportunity down the line. They will need to have validated their business model and show that they can deliver on what they promised. If they are targeting non-accredited investors, their reason for investing could be more altruistic. They need position their campaign to what the investors really care about.
Recently I had a talk about the future of the crowdfunding industry with Lakshmi Narayanan who is developing a fintech platform. His opinion is that, “Today’s platforms are product-focused (debt, equity and donation), the future is going to be in industry-specialized platforms, because there is a need for the industry to have knowledge to choose between opportunities. Already there are over 400 real estate platforms. The regulators will also bring more regulations for the platform operators, professional crowdfunding investment advisory services industry will emerge as part of this ecosystem, rating and ranking by third party and participation of institutional investors on all offerings will become the order of the day. ”
The crowdfunding industry is only ten years old and is already estimated to be $15 billion. Equity crowdfunding is less than five years old. It’s amazing how far and fast the industry has evolved. It’s hard to predict the next ten years but at the rate it’s growing, the capital raising process will never be the same again. All of these changes will provide more access to capital for small businesses, which will help them grow and flourish.