Equity crowdfunding lets start-ups sell shares to average Joe or Jane
Starting Friday, you’ll be able to invest online in privately held companies that could be the next Snapchat Inc. or Tesla Motors Inc., and you won’t even have to be rich or well-connected to take advantage.
New federal regulation has loosened a Great Depression-era restriction that limited opportunities for people without significant wealth to purchase private shares.
The new rule could mean more lucrative prospects for businesses that have had difficulty scoring capital from venture capitalists and other rich individuals, and instead open the door to raising money from loyal, early fans.
“The changes are the greatest advancement for entrepreneurship in a generation,” said Ron Miller, a Los Angeles venture capitalist who as an entrepreneur had to raise capital through credit cards, bank loans, corporate investors and Nasdaq pink sheets. “This is opening up a whole new opportunity.”
Thanks to the new rule, which stems from the 2012 Jobs Act, start-ups can issue shares to anyone — raising as much as $50 million in the process — as long as the companies complete expensive financial and legal paperwork.
How many start-ups will actually pursue the average-Joe or average-Jane investor is uncertain.
“Initially, you think this is going to be the best thing in the world,” said Bill Clark, chief executive of online investment service MicroVentures. “But when you read it closely … it’s not going to be widespread. There’s just too many regulatory issues.”
Specifically, taking investments from the wider public triggers extra disclosures and reporting, and some financing experts expect only a slim class of entrepreneurs will want to spend more on consultants to handle it.
Xreal, a new mobile game publishing company in Santa Monica, is giving it a shot. The company, started by YouTube star Jordan Maron and Activision Blizzard co-founder Howard Marks, has a mobile app, “Fortress Fury,” that received 1.5 million downloads in its first month. Now Xreal wants to grow the tower-construction game and needs money to do it.
On Friday, Xreal plans to begin using an online service created by Miller to gauge how many people want to commit to investing at least $500 in the start-up. If there’s enough interest, Xreal will use new equity crowdfunding service StartEngine to collect money.
Maron said he wants to tap the nearly 8.7 million fans of his YouTube account, CaptainSparklez, and let them share in his success — or failure.
“We’re thrilled to be raising funds in a progressive and personal new way that better resonates with my generation,” Maron said.
Miller estimated that more than 95% of investors could come from the “non-rich” demographic.
The fundraising will work similarly to Kickstarter and Indiegogo, websites where companies or individuals receive small chunks of cash from dozens of people, who in turn receive discounts, first-generation products or giveaways. About $16 billion in capital moved through rewards crowdfunding services in 2014.
In contrast, on StartEngine and other equity crowdfunding platforms, supporters get stock.
Since the Jobs Act passed three years ago, several of those services have been able to funnel cash from wealthy investors to start-ups, including more than $100 million to about 340 tech companies in the U.S., according to data from tracking firm Crowdnetic.
The number could grow rapidly now that anyone can invest. The rule change goes into effect Friday, about three months after the Securities and Exchange Commission completed a lengthy process to define the regulation.
Before, sales of private stock had been limited to people whose most recent two-year income exceeded $200,000, hold a net worth above $1 million excluding their home or control more than $5 million in assets. Everyone else had been able to invest under only special conditions, such as already having an established relationship with an entrepreneur.
Those standards were designed to protect retail investors from being duped by some of the highest-risk bets out there. But they also restricted access to the biggest rewards — like a $5,000 investment in a rising social media company becoming worth $5 million when it goes public — to an elite group.
In the tech industry, the setup concentrated significant power among venture capitalists, a cadre of typically older, white and male investors. That left out minorities, women and those without relationships in the VC world, Miller said.
Renee Farris, 30, is among the newly liberated individuals excited to invest. Farris, a Los Angeles writer, said she imagines investing up to $5,000 a year in environmentally responsible start-ups.
“Investing in a company that has no track record, that isn’t pulling in revenue — it’s risky,” she said. “But there’s a risk to make a lot of money too.”
Even though the barrier to entry has now been lowered for the public, financial experts worry that the number of companies ready to endure the new rule’s requirements will turn out to be small.
But some start-up founders are considering the opportunity because they want to spend less time fundraising via traditional channels and want access to anyone who will fork over money. Reaching out to the general population for capital is also appealing for start-ups that cater to a niche audience and have struggled to persuade big venture firms to give them a chance.
Take Urbn Havn, a San Francisco start-up that rents out luxury homes for short stays and corporate getaways. Silicon Valley and Los Angeles investors aren’t jumping at the chance to be involved, co-founders Jan Hoepper and David Chou said.
“The investors have been bitten by the big game-changing start-ups,” Chou said, noting that his start-up will be smaller and slower-growing.
Urbn Havn secured one major investor, but needed more cash. By widening the pool of potential funders to anyone with Internet access, the duo think they can cobble together $1 million from people who would then control 10% of Urbn Havn.
“We want to find people who understand there’s a need for products like this in the world and not just the things that go mass and infinite,” Chou said.
Urbn Havn plans to offer shares to the public through FlashFunders, an online equity funding platform, in part because it saves start-ups as much as $50,000 by handling legal and finance tasks for them. Despite wanting to turn millennial customers into investors, Urbn Havn decided against taking money from lower-income individuals because of the additional costs.
The SEC and several states, including California, are debating further changes to adjust rules that hinder start-ups from accepting anyone’s cash.
The concern among some lawmakers is that too much leeway will lead to fraud, targeting groups such as the elderly.
Miller is out to prove that isn’t the case, noting both that gambling mecca Las Vegas is open to all and that Kickstarter has seen few cases of fraud.
“We haven’t given up,” he said. “Entrepreneurship sectors will be significantly aided by the availability of crowd finance.”
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