Equity Crowd Funding – Challenges abound

Next week marks the one year anniversary since President Obama signed the Jumpstart Our Business Startups (JOBS) Act. The Act holds a great deal of promise for startup companies and small investors by facilitating a form of investing for the masses call equity “crowdfunding”. Crowdfunding already exists as a way of donating money online to a cause or project through a web portal such as Kickstarter. The idea is to extend this concept to investing where an individual investor can contribute a small amount of money (e.g. $100) and become a shareholder of a company. In addition to the explicit goal of creating new jobs, the Act offers unique benefits for both small investors and startups. Startups often struggle to raise money through traditional sources such as venture capital where only about 1% of firms are ultimately funded. In theory, the Act will provide these firms access to an entirely new set of investors. For small investors, the Act can allow them the opportunity to pursue the dream of owning a share of (albeit a miniscule one) the next hot IPO like Facebook. At least that’s the theory anyway.

A lot has been written about the JOBS Act and pending equity crowdfunding initiative in the past six months including an excellent article by Gary Emmanuel last month in the Huffington Post. The reality is that equity crowdfunding is still probably a year away and, even when it becomes available, will still present numerous challenges for everyone involved. The SEC is struggling to revise Regulations A and D to accommodate online solicitation and allow much larger numbers of unaccredited investors. While striving to meet the objectives of the JOBS Act, the SEC must still maintain its mandate to protect individual investors. As a result, startups may find the regulatory requirements of preparing for a crowdfunding offering, and then maintaining mandatory investor communications, may be too overwhelming to justify the potential to raise up to a $1 million in crowdfunded capital. There is also the possibility that the cap table of a crowdfunded startup could present too much of a headache for professional investors to consider coming in to provide a follow on round, leaving the startup dead in the water.

When fully implemented, the equity crowdfunding aspect of the JOBS Act promises new investing opportunities for small investors and a new source of capital for startups. However, the reality is that the very regulations put in place to protect these constituents may ultimately mean that crowdfunding is not a viable alternative for most companies. The bottom line is that crowdfunding is not likely to be the equity capital panacea that many had hoped and startups will need to keep their options open in their plans to seek funding for their businesses.

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