In perhaps the biggest change to hit small-business fundraising in the last 80 years, the Securities and Exchange Commission voted on Friday to enact the final rules of the Jumpstart Our Business Startups (JOBS) Act, which President Obama signed into law in 2012.
The new rule, known as Title III, will allow you to access a wider pool of investors than ever before--for instance, family, friends, and other interested parties who may not be Rockefellers. It will also unleash the nascent equity crowdfunding industry to become more important gatekeepers of small-business financing.
Title III--conceivably the most important part of the JOBS Act, at least as far as startups go--allows unaccredited investors to buy into private companies, including startups and other small businesses. These companies can also start publicizing investing opportunities--this hasn't been legal since before the Great Depression. While Title III was meant to help businesses raise money as banks pulled back and stopped lending in the aftermath of the financial crisis, the section got held up for years as the SEC tried to figure out the best way to protect investors and businesses from potentially reckless speculation.
"This may seem like a simple endeavor, but it has been a big undertaking," said SEC Commissioner Kara Stein during the morning hearing in Washington, which was presided over by chairwoman Mary Jo White. "This protects small businesses who want a reliable market to raise capital," added Stein.
Here's what you need to know about the new crowdfunding rule:
1. How much you can raise.
Small businesses will be able to raise up to $1 million during a 12-month period from unaccredited investors. They will, however, have to submit to an informal audit and produce documentation that describes investor and financial risks, says Georgia Quinn of Ellenoff Grossman & Schole, a New York City-based law firm that specializes in securities law. "The real power and excitement of this is that it creates a new channel for businesses that are starved for capital," Quinn says, adding the average small business raise is for $170,000.
2. How much investors can invest.
In any 12-month period, unaccredited investors will be able to invest $2,000, or up to 5 percent of their income if they make less than $100,000, in company shares. Investors with annual income or a net worth of more than $100,000 can invest up to 10 percent of their income, up to $100,000. (An unaccredited investor, generally, has less than $1 million in liquid assets and earns less than $200,000 annually.)
3. How to sell shares.
Sales will be handled via regulated funding portals that will act as gatekeepers, vetting investments and providing critical investment information to investors. In its hearing today, the SEC suggested the primary model would be internet portals, such as those that already exist in the crowdfunding world. Investors should, in theory, be able to sell those shares to secondary markets, as Inc. has previously reported. Commissioner Luis Aguilar, in his morning testimony, expressed concern that the secondary market for such shares was not robust enough to support the regulatory changes. Platforms such as SecondMarket and SharesPost already exist for accredited investors to buy and sell shares of private startups, and they could now face increasing competition. If nothing else, the cost of capital for all companies that now want to issue shares is likely to go down, SEC regulators said.
4. When it will kick in.
The new rules will move to the Federal Register as an official notice for 60 days, where it's possible--though unlikely--they could be legally challenged, Quinn says. Title III will then be enacted six months later, according to the SEC.
The changes mean that crowdfunding sites such as Kickstarter and Indiegogo now have an opportunity to sell shares of the companies they represent to customers, pending regulatory approval from the Financial Industry Regulatory Authority, a federal regulator of broker-dealers. Currently, such crowdfunding platforms allow companies to raise funds from customers who do not take an equity position in the company.
Slava Rubin, the founder and chief executive of Indiegogo, says the rule change is an exciting development that will allow more small companies to raise capital, potentially on Indiegogo.
"It has always been part of our vision since we launched in 2008 to include equity fundraising," Rubin says.
Other platforms, such as StartEngine, have been allowing unaccredited investors to purchase shares in much larger capital raises, of up to $50 million, following an enactment of something called Regulation A+ by the SEC this summer. Ron Miller, StartEngine's chief executive, says that dozens of companies have approached him in recent months about smaller sales.
"Most of these companies are seeking to raise in the $500,000 to $1 million range," Miller says.
In today's meeting, the SEC also voted to amend two sections of securities law, known as rule 147 and rule 504 of Regulation D, which govern private, intrastate fundraising. The SEC has essentially made it easier for companies that want to do non-crowdfunded raises to claim in-state status. Also for this group, the SEC increased annual fundraising limits to $5 million, from their current threshold of $1 million. That's important for e-commerce companies that may have previously been excluded from this kind of fundraising because the SEC deemed not enough of their operations were in the state.