After more than a year of delays in crafting a workable proposal around the most controversial part of the Jumpstart Our Business Startups Act, the Securities and Exchange Commission has finally given birth to regulatory guidance for equity-based crowdfunding that would enable entrepreneurs to solicit funds from the general public over the Internet in exchange for equity.
The implications of this will certainly be important for L.A.’s burgeoning tech community, which is concentrated in Santa Monica. But other entrepreneurs could benefit as well.
While donation- and reward-based crowdfunding models – made popular by the likes of Kickstarter and Indiegogo – have been operational and welcomed, the idea of “crowdinvesting” received wide support within the entrepreneurial community only to be ridiculed by many lawyers and the old establishment of bankers and investors.
It remains to be seen if the 580-page SEC document will be able to ensure what both camps envision – a feasible framework that empowers new businesses to reach for much more capital on the one hand and a solid base for protecting immature investors on the other.
The public will have 90 days to respond to the SEC’s proposal. To me, the watchdog is certainly moving in the right direction, even if it is moving with a great deal of caution.
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 a total of $1 million a year, and businesses seeking a capital round of more than $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 (which is about 9 million households).
The SEC’s proposed restriction is that everyday citizens making less than $100,000 will able to invest 5 percent of their annual income and 10 percent for those who are making more than $100,000. The imposed “safety caps” seem a bit biased, though. Shall we enforce caps on gambling (a $34 billion industry)? Or maybe shoe purchases (sorry, ladies)?
Fear of public
I have been astonished at the energy some put into addressing their fear of letting the public into the world of private investment – even with “caps.” Who else do they think is available?
Venture capitalists and angel investors combined invest around $55 billion a year – not a large amount of money if you compare it with the capital deployed by finance and insurance companies, also known as Wall Street, which reached $1.2 trillion last year (8 percent of GDP).
Venture capital investors and angels are also looking for up to 40 times return to make up for their prior losses, which means that they target businesses with a clear exit strategy. Such pearls occur almost solely in high tech. As a result, retail industries or social care, for example, have been largely overlooked.
It has also brought a notorious gender cap when women-owned businesses receive only 1 percent of VC capital: Most female entrepreneurs start companies outside of the high-tech realm. The good news is that, to date, more than 60 percent of crowdfunded businesses have been started by women. This clearly indicates that the crowdfunding model has great potential to spread capital across a much wider scope of industries. Do we need another Twitter, people?
Many of us locked in on a belief that new investors will seek pure financial returns and need a “portfolio approach.” But what does the crowd really want? Social causes were the most popular crowdfunded category in 2012. The amount of charitable donations in the United States, reaching $300 billion annually, is 10 times bigger than VC investments. Europe, where equity crowdfunding is legal, reports the most traction for social enterprises.
Imagine the world where funding decisions would be voted by the wallets of the crowd. My belief is that crowdinvesting has substantial promise to become that exact impact investment we’ve been all craving for. Let’s give it a try.
Victoria Silchenko is the founder of Metropole Capital Group in Century City and the organizer of the 2nd Annual Next Generation Entrepreneurship and Global Crowdfunding Forum in Santa Monica on Nov. 15.