Who Let the Dog Out: On New Crowdfunding Rules and Why It Is Time for Us to Wise Up
For that was the date on which the Securities and Exchange Commission (SEC) finally issued their delayed by 15 months proposal (Title III of the JOBS act) enabling entrepreneurs to solicit funds from the general public over the internet in exchange for equity.
Who can blame you if you haven’t had a chance to study the full 580 page document, but there are a couple of key points to be aware of.
For those who are seeking funds, there are at least two significant impositions: the capital that can be raised from the general public will be limited to $1 million a year; and businesses with a capital round of over $500,000 will have to present annual reports and audits.
But the truly revolutionary changes are expected on the investment side. For the first time in 80 years, the regulation will allow everyone to invest into privately held companies – an opportunity permitted currently only to those with an annual income of $200,000 or a liquid net worth of at least $1 million.
The implications of the SEC’s move will be certainly one of the key topics of our 2nd annual Next Generation Entrepreneurship and Global Crowdfunding Forum to be held in Santa Monica on November 15th.
Meanwhile I have been asking my peers for their initial thoughts on the new rulings which, once enforced, might transform the financial system as we know it.
If VCs could talk
Tim Draperis one of the most prominent (and charismatic) venture capitalists with a truly impressive portfolio and also a third generation of VCs in Silicon Valley. On my quest, Tim revealed where he stands:
“The JOBS Act is terrific legislation, good for small businesses, good for job creation, good for the country, good for the world. The regulations that have been added don’t appear to be too stringent, but having the issuers “register with the SEC” sounds like the camel has its nose in the tent. Also, there is something that says foreign companies can’t use Crowdfunding, which I believe is a little myopic. Overall, I hope this passes the comments phase with few changes, and we get a chance to try it out. One note for individual investors: buyer beware! I recommend investing in private companies, but you will likely lose your money 70 percent of the time. You are best thinking in terms of investing in 20 or more of these to get proper diversification. Otherwise, welcome to the venture capital business. It is great fun”.
I have written before about why crowdfunding will surpass the VC industry and I echo Tim’s position. If you don’t want the public getting into the game, who else do you think is available?
The truth is that VCs are targeting businesses with a clear exit strategy. Such pearls occur almost solely in high-tech. As a result, consumer-based or social care for example, have been largely overlooked. The approach, which has left 99 percent of businesses out of the pipe support, has also brought an infamous gender cap when women own about 30 percent of US businesses — and only 3 percent get investments from venture capital (Ernst & Young report). I am no surprised – most female entrepreneurs start companies outside of the high-tech realm. Equity based crowdfunding might bring the forgotten by VCs dividend model and spread capital across a much wider scope of industries.
Fraud is not an issue – naivety is
Slava Roubin, the founder of Indiegogo, shared with me that he “supports equity crowdfunding as a natural progression of the perks-based model by giving Americans the opportunity to invest in the projects that matter to them”.
How about notorious fraud? Slava believes that “crowdfunding in itself is a great deterrent for “false” campaigns because it’s up to the crowd to determine what’s “legitimate.” In addition to receiving a brief description of the proprietary algorithm that allows a leading donation based platform to flag potentially fraudulent campaigns, I also got Slava’s bullet points which you might call a do-it-yourself guide to spotting a fraud:
• Pitch: the campaign page/pitch should answer who, what, where, when, and why. The more information and though contained, the more legitimate the campaign is likely to be.
• Initial funds: for virtually all campaigns, your first funds come from friends/family (about 20-40 percent). If the campaign doesn’t have at least 20 percent of their goal met (within a few days) proceed with caution.
• Active links: Look for links to other places to find the campaign (Twitter, Facebook, official website, press coverage, etc.). This showcases the community the campaign has built to-date and track record of execution – i.e. what they’ve done. A history and network are great validation for campaigns.
• Updates: Has the campaign owner updated the campaign? If they’re engaged in dialogue with their contributors (posts updates every 1-5 days), it’s more likely to be a legitimate campaign.
If you play poker you would agree that a careful analysis is part of the fun. So how about getting smart in the investing game too?
Real fans wanted
Colin Magham belongs to a group of people adoringly called angel investors which last year counted only 268,160 active members (out of 8.99 million U.S. households with accredited status) investing a combined $22.9 billion. Colin, who is also an entrepreneur himself, brought up an interesting point about equity based crowdfunding:
“This is where the real power of things like peer ratings systems, which have been made mainstream by eBay in commerce and the likes of Quora in knowledge share, could create powerful funding ecosystems that can flourish and sustain themselves. A deep and wide reaching platform that attracts and qualifies financial backers that are also real fans who will gladly, compellingly, and even loudly promote your company fueled by their sense of ownership and affinity for what you stand for, and the good things your venture will bring into the world.”
Many of us seem locked into a belief that new “crowd- investors” will seek pure financial returns. But the reality is that such market exists already – it is called Wall Street and on average stocks are still the most profitable investment. There are also commodities or real estate — passive investments with no impact, in other words.
When I asked Korstiaan Zandvliet, a founder of Symbid (Netherlands), the first equity based crowdfunding platform in Europe, with 23 ventures successfully funded as of today (and no fraud), which industries have been the most popular among crowd-investors, he revealed that “investments are industry agnostic”, and that “social cause ventures have better performances on the platform”. Are you thinking what I am thinking?
Welcome to the upgraded version of capitalism.
Victoria Silchenko is the founder of Metropole Capital Group and creator of the annual Next Generation Entrepreneurship and Global Crowdfunding Forum in Los Angeles