Crowdfunding 2.0: Even You Can Invest in the Next High-Growth Startup
Crowdfunding 2.0: Even You Can Invest in the Next High-Growth Startup
A new legal framework changes the rules of the game for U.S. crowdfunding

Crowdfunding—an online method of soliciting money from the general public for a business, project, or cause—is about to go through a seismic shift. And it could mean insane profits for some investors—profits that were previously unattainable due to government regulations.

We are talking about the potential for the kind of jackpot enjoyed by early investors in high-growth startups like YouTube and Facebook. We’ve all heard stories about the lucky janitors who cashed out on equity after an IPO or acquisition and bought million-dollar homes and a Porsche, or two, or three.

For the fact that millions of crowdfunding investors have been shut out of this opportunity until now, one does not have to look back very far for a lesson in extreme disappointment.

Virtual reality technology company Oculus VR Inc., which manufactures the hotly anticipated Oculus Rift headset, raised $2.4 million on the popular crowdfunding site Kickstarter, largely from the gaming and developer community it serves.

When Oculus VR was acquired by Facebook for $2 billion, its more than 9,000 crowdfunding supporters who helped launch the company got nothing.

When the startup was later acquired by Facebook for $2 billion, its more than 9,000 crowdfunding supporters who helped launch the company got nothing. 

According to the terms of how rewards-based crowdfunding works, Oculus had simply stated on its campaign page the money was to fund development kits of the Rift.

People wear Oculus goggles as they test out the Minecraft for Gear VR at a press demonstration at The Village event space in San Francisco on March 15, 2016. (Gabrielle Lurie/AFP/Getty Images)
People wear Oculus goggles as they test out the Minecraft for Gear VR at a press demonstration at The Village event space in San Francisco on March 15, 2016. (Gabrielle Lurie/AFP/Getty Images)

In the United States, the law restricts equity investment to ultra wealthy accredited investors like angel investors, banks, sharks, and venture capitalists. The game enthusiasts who supported Oculus were allowed to receive only physical rewards or perks.

In exchange for a financial donation, investors in Oculus who pledged at least $300 were the first to get a headset, and benefits went up from there in accordance with the dollar value pledged. Donations of less than $300 got people perks like branded T-shirts and posters.

Being the first to get a coveted product, or simply gaining the satisfaction of helping an entrepreneur achieve his or her dreams, has been satisfying enough to lead millions of people in the United States to invest via crowdfunding, but isn’t getting a big financial return even better?

Crowdfunding Landscape

Crowdfunding is a way for a business venture or cause to raise money in small increments from ordinary people.
Crowdfunding is a way for a business venture or cause to raise money in small increments from ordinary people.

For those still unfamiliar with crowdfunding, you may be missing out on a way to align your dollars with your values, which is one of the investment channel’s biggest lures.

Crowdfunding is wildly popular, with over a million campaigns funded for a total of $16.2 billion worldwide in 2014, up 167 percent from the previous year, according to a recent industry report by Massolution.

Aside from reward-based crowdfunding on popular sites like GoFundMe, Kickstarter, and Indigogo, one of the fastest growing categories of crowdfunding is lending based.

Equity-based is a category already available to investors in Israel, Europe, and parts of Asia.

Prosper and LendingClub, the two biggest lending-based crowdfunding sites, did a total of $6 billion in transactions in 2014 and grew at a rate of 223 percent from the previous year, according to Massolution.

Other categories include donations-based, royalty-based, hybrid models, and finally, equity-based.

Equity-based is a category already available to investors in Israel, Europe, and parts of Asia, with the United States being a notable exception in the developed world.

The JOBS Act

Finally, after years of lobbying by crowdfunding advocates, the opportunity for Americans has nearly arrived.

Signed into law in April 2012 as part of the Jumpstart Our Business Startup ACT (JOBS Act), and after three years of rule-making to establish a regulatory framework, crowdfunding investors will have the opportunity to invest in a piece of the next big startup starting May 16.

The law levels the playing field for information and access to opportunity for everyday investors.
Slava Rubin, founder and CEO of Indiegogo, in San Francisco on June 20, 2013. (Neilson Barnard/Getty Images for The New York Times)
Slava Rubin, founder and CEO of Indiegogo, in San Francisco on June 20, 2013. (Neilson Barnard/Getty Images for The New York Times)

“It’s going to be awesome. It’s going to create chaos,” said Slava Rubin, CEO and chief business officer of Indiegogo, at a recent Food+Enterprise event in New York. Rubin said Indigogo plans to tap its current customers and help them to become part of the upside of equity crowdfunding.

The law levels the playing field for information and access to opportunity for everyday investors.

According to Chance Barnett, CEO of crowdfunder.com, writing for Forbes, this will be the first time in over 80 years that average citizens will have the chance to invest in early-stage companies.

With the SEC and Financial Industry Regulatory Authority (FINRA) involved, the technicalities of listing a company, as well as investing, are stepping up considerably.

Under the current rewards-based model, an informal honor code is used. Campaigns are expected to list their goals transparently, and there is trust from investors that they will receive the promised reward.

With equity crowdfunding, investors will have to jump through some hoops by registering on an SEC or FINRA-approved platform, and taking some financial literacy training to get qualified.

SEC rules will also limit the amount investors can give. Those with annual income or net worth lower than $100,000 will be limited to between $2,000 and about $5,000 yearly. People with earnings over $100,000 can potentially invest up to 10 percent of their income or net worth, with a $100,000 individual cap.

Companies listing on an equity crowdfunding platform will need to disclose to the SEC and potential investors how they arrived at their company valuation; the background of all officers, directors, and any significant owners; financial statements; and an annual report.

This is similar to what a public corporation is required to do, with a major difference being that companies seeking to raise less than $1 million are allowed to have their financial statements reviewed rather than audited, which is a major cash savings for a new company.

Millennials are thinking about how to invest differently.

Dan Miller, co-founder of real estate crowdfunding investment platform Fundrise, calls the changes under Title 3 of the law a “game changer.”

Speaking at Food+Enterprise, Miller said millennials are thinking about how to invest differently, and crowdfunding connects social networks to the market. He said the platforms for equity crowdfunding will include a chat feature to allow for engagement between parties.

“The banking market is broken. This is one of the ways we are going to fix it,” he said.

Kim Wales, founder and CEO of Wales Capital and CrowdBureau, and a pioneer in working with the government to establish the new provisions, said people today “want to invest in their built environment in places they are connected to.”

For small, independent businesses in particular, she said at Food+Enterprise, “I really think it is going to be a fundamental shift and a big wave globally for the next few decades.”

Chasing Rainbows?

Christopher Mims, technology columnist for the Wall Street Journal, takes a pessimistic view of equity crowdfunding in his piece “Tech Startup Crowdfunding Isn’t All It’s Cracked Up to Be.”

In it, he wrote that people who are busy working on the new platforms to offer the service all share an open secret: “As a mechanism for funding startups like Oculus, it is basically a nonstarter.”

The Moonspike project launched a Kickstarter campaign to build an actual Moon rocket. (Moonspike Limited via AP Images)
The Moonspike project launched a Kickstarter campaign to build an actual Moon rocket. (Moonspike Limited via AP Images)

Mims reported their view is that high-growth startups, particularly tech startups, are very unlikely to use equity crowdfunding because the public disclosure requirements are too high.

Not everyone is giving up on the notion just yet. After all, we haven’t even passed the starting line on the new rules. Nicholas Tommarello, the founder of wefunder, is optimistic that a workaround can be found that appeals to tech startups, according to Mims.

Slavic made the point that “we are entering into a world that doesn’t exist,” and it will be chaos for a while. But “10 to 15 years from now, nobody will talk about it.” 

“One day it will be a boring, huge industry,” he said.


 

Global Crowdfunding Investment

2013: $6.1 billion
2014: $16.2 billion
2015: $34.4 billion

Crowdfunding by Region: 2014

Asia: $3.4 billion
Europe: $3.26 billion
North America: $9.46 billion

Types of Crowdfunding

Lending-based: Capital repayment with interest
Donation-based: Philanthropic donation or gift, no return expected
Reward-based: Contribution in exchange for a perk or a pre-order of a product
Equity-based: Investment for an ownership stake in the business
Hybrid models: $487 million
Royalty-based: Crowdfunders invest in campaign and receive a share of revenue earned in return for their investment

Top 5 Crowdfunding Categories in 2014

Business and Entrepreneurship: $6.7 billion
Social Causes: $3.06 billion
Films and Performing Arts: $1.97 billion
Real Estate: $1.01 billion
Music and recording arts: $736 million

SOURCE: “Crowdfunding Industry Report,” published by Massolution

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