Last Friday, the SEC released its long awaited proposed rules for crowdfunding or put another way: how to find investors online. The new rules and proposed amendments are designed to assist smaller companies with capital formation and provide investors with additional protections.
The final rules, called “Regulation Crowdfunding,” permit individuals to invest in startups via crowdfunding transactions subject to certain investment limits. The rules also limit the amount of money startups can raise using the crowdfunding exemption, impose disclosure requirements on companies for certain information about their business and securities offering, and create a regulatory framework for the broker-dealers and funding portals that facilitate the crowdfunding transactions.
The rules would allow companies to raise $1M online through crowdfunding in a 12-month period by expanding the universe of investors beyond typical angel investors and those who otherwise are “accredited” within the meaning of the securities laws. In fact, under the new rules, people who never would have thought about investing in startups will be able to go online and invest their hard earned money in early stage companies and promising entrepreneurs.
So these rules will revolutionize the way companies raise seed and series A rounds, provide new and much-needed capital alternatives, bring the arcane regulation of securities into the 21st century, and allow companies to raise money faster and more efficiently than ever before all the while harnessing the infinitesimal power of the Internet—right?
Not so much.
- Fees. All transactions relying on the new rules would be required to take place through an SEC-registered intermediary, either a broker-dealer or a funding portal—and that means transaction fees. The rules don’t contemplate that companies will be selling securities to a new category of investors directly from individual company websites.
- Information Requirements. Companies that rely on the recommended rules to conduct a crowdfunding offering must file certain information directly with the SEC —including financials that are reviewed or audited by an independent accountant. They also must provide this information to investors and the intermediary facilitating the offering. On top of that initial filing package, companies relying on the crowdfunding exemption also then would be required to file an annual report with the SEC and provide it to investors. Compiling all that information, whether financial statements or updates for investors in a form appropriate for filing with the SEC, won’t be cheap, easy or fast.
- Unsuitable Investors. Companies undaunted by the additional time, expense, and information requirements of the new rule would be able to reach a new group of less wealthy and less sophisticated investors online and worldwide. Even investors with a net worth or net income of less than $100k will be able to invest.
What could possibly go wrong with that scenario?
Hmmm…..do companies that hope to attract institutional or strategic investment at a later round really want a large group of unsophisticated investors in their cap table? I’ll bet that the answer will be “no” for most promising companies.
Many successful companies get started with a few smart well-heeled investors who can fend for themselves in all matters financial while in turn attracting others like them. Finding and interacting with those potential investors in person, whether through an angel group or old-fashioned serendipity is far more effective than searching for random strangers with money online.
I wish the SEC would focus on how best to allow incentives for those angels themselves to receive commissions (for introductions to other angels) than on “democratizing” investments in early stage—and therefore—risky enterprises, but that is a post for another day……
In short, I don’t see the new rules changing much about the way thoughtful entrepreneurs go about developing a financing strategy, at least in the near term. We’ll hear much more about these rules in the days to come. The new rules and forms should be effective in about six months.