Crowdfunding is here! Part 1

WEEK 1 INVESTORS

Finally, it has arrived!

After three long years the wait is over, and equity crowdfunding is just around the corner.  The new crowdfunding regulations have been released and they become effective on May 16, 2016.  Those seeking to participate in this novelty form of fundraising now have guidance.  There are three parts to the rules: (1) regulations for investors; (2) regulations for the company seeking to raise capital by issuing securities; and (3) regulations for the online crowdfunding platforms.  Over the next three posts we will discuss the three parts in depth.  This week we will look at the investors.

Calling all investors!  Under the new regulations, an unlimited number of individuals may invest in the crowdfunding exemption within a 12-month period.  However, each investor must comply with individual investor limits.  For example, an individual investor may not invest more than a total of $100,000 in an offering via crowdfunding.  And of this total, the actual amount depends on a combination of the investor’s net worth and annual income.  Specifically, the regulations state that if the investor’s annual income or net worth is less than $100,000, the investor may invest either $2,000 or 5% of their annual income or net worth (whichever amount is smaller).  Alternatively, if an investor’s combined annual income and net worth are greater than $100,000, the investor may contribute 10% of either the annual income or net worth (the calculation is based on the smaller amount).  Here’s an easy example.  If the investor’s annual income is $100,000 and her net worth is $750,000, her investment cannot exceed $7,500.  These detailed rules are thought be an attempt by the Securities and Exchange Commission (SEC) to help companies access capital while protecting investors from fraud.

The regulations also prohibit investors from reselling their securities for at least one year after they acquire those securities.  However, even after the one-year restriction period ends, it is unclear whether investors who purchase these crowdfunded securities will be able to find a liquid secondary market in which to resell their securities.  If investors do not have a market for resells, the value of crowdfunding securities could be diminished.

One thing to keep in mind: The SEC predicts that startups relying on crowdfunding to raise capital will experience a higher failure rate than traditional forms of capital formation.  The SEC, perhaps rightfully so, is concerned about the many households where a sizeable gap between net worth and annual income makes it hard to absorb a financial loss.  Crowdfunding advocates counter that the benefits of investment should be available to everyone, not just the wealthy.  How will this play out?  Only time will tell.

– Malika Simmons