You don’t have to be a millionaire anymore to put a few bucks into your favorite brewpub as a silent partner. I’m not talking about quietly paying your bar tab here, but putting real money in for a share of the business. Under new rules at both the national and state levels, businesses will be able to solicit funds from smaller investors using online crowdfunding.
Kickstarter, one of the best-known crowdfunding platforms, has raised $2.4 billion in pledges over its seven-year life, funding creative projects such as indie movies and art works. Donors typically are rewarded with a DVD, a sample product or a T-shirt, but not a financial interest in the ventures they back.
All that is about to change. Under the JOBS Act (Jumpstart Our Business Startups Act), passed in 2012, Congress directed the Securities and Exchange Commission to issue rules enabling businesses to harness the power of crowdfunding and open it up to smaller investors nationwide. States can also issue crowdfunding rules limited to investors and businesses within the state.
The SEC finally issued its rules, Regulation Crowdfunding (Reg CF), which take effect Monday, and Minnesota adopted its own version, called MNVest, along with approximately 30 other states. While the Minnesota Department of Commerce hasn’t yet released its final rules, MNVest is expected to launch in a few weeks, according to Commerce spokesman Ross Corson.
Zachary Robins, an attorney with Winthrop and Weinstine who helped write the MNVest legislation, describes Internet-based crowdfunding as “the democratization of investing.” Instead of a “small slice of Ivy League school graduates” working for big investment banks controlling which firms get funded, “the public decides,” he said.
Even though the nationwide program both opens up a larger potential pool of investors for businesses and presents investors with a wider array of opportunities, Robins believes MNVest and other state-run programs will play an important role because their rules are less restrictive than the federal rules.
• Under Reg CF rules, individuals with income or net worth under $100,000 are limited to investing the greater of either $2,000 or 5 percent of their income or net worth in a year. Those with income or net worth in excess of $100,000 are held to 10 percent of income or assets. Under MNVest, a qualified investor is limited to $10,000 per investment, but can make multiple investments in a year.
• The SEC rules cap the amount that can be raised at $1 million annually while MNVest caps it at $2 million.
• Under both Reg CF and MNVest, companies are required to disclose certain information, including 12 months’ worth of financial statements that have been reviewed or audited by an independent accountant. But the threshold for disclosure kicks in at $100,000 of capital raised under federal rules while the state does not require financial disclosure until $1 million is raised.
• The federal rules require ongoing financial reporting, but MNVest does not.
Looser disclosure rules may expose MNVest investors to greater risk of abuse. “While MNVest may be an opportunity for local businesses to raise capital, there is also the potential for investor abuse or fraud,” said the Department of Commerce’s Corson in an e-mail exchange. “Investors choosing to participate in a MNVest offering should carefully consider all the risks involved, including the potential that they may not see any return on their investment.”
Corson added that the Commerce Department “fought for additional consumer protections,” not all of which were included in the bill the Legislature ultimately passed.
One important distinction between any crowdfunding investment and regular stock investments, under both federal and state rules, is that crowdfunding investors are limited in reselling their securities in the first year. Even after a year, there is no stock exchange to unload a bad investment or cash in. Investors will have to find a buyer on their own.
Crowdfunding investors will still have to work through a registered portal, though those portals do not have to be traditional brokers. Attorneys, accountants, marketing firms and entrepreneurs can register themselves as portals.
Companies most likely to take advantage of crowdfunding are small businesses that traditional venture capitalists are ignoring, attorney Robins said. “If a business can’t provide a 10X return, it’s very difficult to find angel investors to back you,” he said. Most traditional businesses provide a lower return but also are less risky, he added.
But Robins also said that crowdfunding will be expensive until the industry matures and more sophisticated software automates the process. Legal fees alone could total $10,000 per deal. Add in accounting fees, escrow and bank fees, marketing and distribution costs, and he concludes that “these offerings are not going to be cheap. It’s still a complex transaction.”
Brad Allen is a freelance writer and former investor relations executive for companies including Imation Corp. and Cray Research. His e-mail is email@example.com.