A new form of crowdfunding is coming soon that will allow startups to raise money by selling stock to Main Street investors.
The Securities and Exchange Commission on Friday adopted rules implementing a 2012 law that opened the door to securities crowdfunding. The vote was 3-1 at a public meeting.
For years, artists, charities and entrepreneurs have used the power of the Internet to generate money for projects. Now starting in mid-2016, businesses will be able to offer investors a piece of their company by legally selling stock online.
For investors, it’s a chance to make a small profit and possibly get in early on the next Twitter, Instagram or Uber.
But it’s also entails high risk, given that a majority of startups fail. About half of all small businesses shut down within the first five years. Some critics also warn that investment crowdfunding is ripe for fraud.
The new SEC rules “won’t prevent the kind of fraud” that can arise in conventional online scams, said Mercer Bullard, a law professor at the University of Mississippi who is a mutual-fund investor advocate.
“You can embezzle someone’s money in the guise of making a securities offering,” Bullard said in a telephone interview.
With an eye to protecting investors, the crowdfunding securities offerings can only be made through brokerage firms or new Internet funding portals which must be registered with the SEC.
SEC Chair Mary Jo White said before the vote that agency staff “will begin immediately to keep a watchful eye on how this market develops.”
They will assess what kinds of companies use the new crowdfunding offerings, how closely they follow the rules and whether the new practice promotes the raising of capital while also protecting investors.
Under the new rules, people with annual income or net worth less than $100,000 will be allowed to invest a maximum of 5 percent of their yearly income or net worth, or $2,000 if that is greater. Those with higher incomes can invest up to 10 percent. An individual can’t invest a total of more than $100,000 in all crowdfunding offerings during a 12-month period.
Investors generally couldn’t resell their crowdfunding securities for one year.
For their part, companies will be allowed to raise a maximum of $1 million a year from individual investors without registering with the SEC. Companies will have to provide information to investors about their business plan and how they will use the money they raise, as well as a list of their officers, directors and those who own at least 20 percent of the company.
The SEC was given some discretion in the 2012 law, known as the JOBS Act, in the information to be demanded from companies and limits imposed on investments.
Republican Commissioner Michael Piwowar voted against the crowdfunding initiative because he said the new rules were too strict and will discourage many companies from participating.
The SEC proposed the crowdfunding rules two years ago. Waiting at the starting gate for the final rules to take effect: legions of startups in areas such as packaged food, medical and biotechnology, restaurants and real estate.
The goal of the 2012 law was to help entrepreneurs raise money quickly when they couldn’t attract attention from venture capitalists or traditional deep-pocketed investors. At the same time, the law eased the SEC’s regulatory reach by giving the startups an exemption from filing rules. The rationale was that new businesses in a hurry to raise money would be hampered by having to submit paperwork. It was an about-face for Congress after expanding the SEC’s powers only two years earlier in response to the 2008 financial crisis.
Supporters say investment crowdfunding could be a boon to the economy: more businesses create more jobs and that boosts economic growth. And many of the companies that could benefit are in overlooked areas of the country, such as the Midwest or Southeast, the promoters say.
But some investor advocates and other critics express concern that this new arena of investing could be a breeding ground for fraud.
The state securities regulators’ association warns investors to be “extremely cautious” about crowdfunding. It says companies raising money this way may be inexperienced or even fraudulent. Investors may be on their own to pursue private lawsuits against companies when things go awry, and it may be difficult or impossible to resell the securities.
5 things you need to know about crowdfunding investing
A new kind of crowdfunding will give the average American a chance to invest in small companies and startups. But before you think about jumping in, there are some important things to keep in mind.
Under the new rules from the U.S. Securities and Exchange Commission, small businesses can raise up to $1 million a year by selling stakes in the company. The money raised may be used to grow the business. Early investors can earn money if the business succeeds. But the North American Securities Administrators Association urges caution to those thinking about giving their money to a startup.
Here are some tips:
— WAIT: The rules won’t go into effect until sometime next year, and the exact date is not known yet. So sit tight and be wary of companies seeking cash right away.
— KNOW THE RISK: Buying stock in any company, large or small, carries risk. But small businesses and startups can be even risker, the NASAA said. Some 50 percent of small businesses fail within their first five years.
— RESEARCH: Make sure to ask questions about the finances of a company you plan to invest in, such as how much revenue it earns and if it’s profitable. Also research its founders and check their track record with past businesses.
— INVESTMENTS MAY BE LONG-TERM: Know that you may be stuck with an investment for a long time. The NASAA said it may be hard or impossible to sell stakes that you may buy.
— KNOW THE RULES: The SEC put caps on how much money people can invest. Those with annual income or net worth below $100,000 can invest up to 5 percent of their yearly income or net worth, or $2,000 if that is greater. Those who earn more money can invest up to 10 percent. But no one can invest more than $100,000 in crowdfunding offerings during a 12-month period.
— Associated Press