Since May 16 the Securities and Exchange Commission has allowed the 99 percent to join top investors in the Securities-based Crowdfunding of private companies. Crowdfunding is a financing method that allows companies to solicit small individual investments from the general public during the start-up and beginning stages of development. While the basic premise is similar to that of Kickstarter, which launched in 2009, Securities-based Crowdfunding allows investors to receive an equity stake in the fledgling company, rather than first dibs on the future product or experience. The SEC and its new rules regulate only Securities-based Crowdfunding.
The new rules allow the “99 percent” to participate in investing, and move away from a longstanding SEC policy that required private companies to be financed by only “accredited” investors. “Accredited” investors are those who earn $200,000 per year and have a net worth of $1 million or more. Although limits on an investor’s contributions during a twelve-month period still depend on net worth and annual income, the thresholds have been lowered considerably. A SEC press release announced in February:
“If either your annual income or your net worth is less than $100,000, then during any 12-month period, you can invest up to the greater of either $2,000 or 5% of the lesser of your annual income or net worth. If both your annual income and your net worth are equal to or more than $100,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $100,000.”
Notably, an investor’s primary residence is not included in calculating her net worth.
While many Americans hail this change as the democratization of the market, others see crowdfunding as an unrealistic financing method, and some liken it to gambling. The new rules prohibit companies from raising more than $1 million through crowdfunding in a twelve-month period, and compliance costs coupled with professional fees may burden start-ups. The SEC – which has been tinkering with these rules for years as part of the Obama administration’s 2012 Jumpstart Our Business Startups (JOBS) Act – warns that no company is guaranteed to reach its financing goal through crowdfunding, and investors may be left in the lurch. Further, crowdfunding investors may be subject to the little-known Unrelated Business Taxable Income tax.
Still, Crowdfunding may diversify the market, whereas venture capitalists disproportionately fund white male entrepreneurs in the Bay Area, Boston, and New York. A 2015 study indicated that female entrepreneurs tend to be more successful in financing their ideas through crowdfunding than their male counterparts due to more advanced linguistic skills and the Internet’s mitigation of gender bias.
Companies looking to take advantage of the new rules can be either in the startup stage or already established and looking to expand their operations. The most successful crowdfunding campaigns however, tend to be tech companies. Nevertheless, the new SEC rules set free the entrepreneurial spirit of both creators and investors, and open yet another avenue to achieving the American Dream.
Rachel Raimondi is a third year law student at Wake Forest University School of Law. She holds a Bachelor of Arts in Communication from the University at Buffalo. Upon graduation, she intends to practice transactional law.