Equity Crowdfunding Stalls

When President Obama signed the Jumpstart Our Business Startups Act in April 2012, the clock began ticking on a 270-day period for the Securities and Exchange Commission to write regulations which would govern crowdfunding. This 270 period is finished and no regulations exist. SEC Chairwoman Mary Schapiro, never a proponent of crowdfunding, quit her job at the end of 2012 after taking a very deliberate approach to formulating the rules. Three leading deputies, one of whom was charged with overseeing the writing of the principles, also left. It’s now generally thought that the principles won’t be completed before the end of 2013 and equity crowdfunding won’t begin until early 2014.

Affluent Investors Only

In anticipation of the SEC promulgating regulations within the mandated timeframe, a range of equity crowdfunding websites really went live in 2012, encouraging entrepreneurs to ready their crowdfunding campaigns. Now, many are finding creative ways to work within the present law which allows only accredited investors — people who have a net worth of more than $1 million or earnings over $200,000 for the past two years — to finance businesses. One, CircleUp, which is focusing on the food industry, has partnered with SecondMarket, a registered dealer which joins accredited investors with investment opportunities through an internet platform and WR Hambrecht, a registered broker dealer. CircleUp has also partnered with AngelList, a group of angel investors like Reid Hoffman, founder of LinkedIn, who focus on technology investments. Another firm, EarlyShares has united with agent dealer Point Capital Partners.

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CircleUp is a crowdfunding website that relies on licensed — wealthy — investors.

One benefit of the agent dealer partnerships with crowdfunding websites is that if the financing is available only to accredited investors, the size of the increase could be anywhere from $100,000 to $5 million. In contrast, the equity crowdfunding law limits start-ups from increasing more than $1 million each year.

While lots of these relationships might be temporary — allowing crowdfunding sites show some momentum when waiting for the regulations to be adopted — others might persist, offering entrepreneurs a mixture of accredited investors that can make bigger investments with the non-accredited investors who would have the ability to invest smaller amounts. But, accredited investors may balk at ridding their investment by sharing rights with substantial quantities of small investment partners and pull from those arrangements when equity crowdfunding starts.

A Good Year for Donation According Crowdfunding

Meanwhile, donation-based crowdfunding undergone a stellar performance in 2012. Kickstarter alone financed 18,109 jobs with 2.2 million individuals pledging a total of nearly $320 million to campaigns. Other crowdfunding websites haven’t made their totals available.

Though some donation-based websites may enter the equity side when the rules are set up, others say they find the constraints required by the law overly onerous. In 2012, several technology projects increased significantly more funds the $1 million each year limitation. And there’s definitely an advantage to not have to answer to investors and dilute ownership in an organization.

Kickstarter eased over $300 million of donation financing in 2012.

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The Demand for Alternative Funding Mechanisms

The delay in equity crowdfunding is very problematic right now because other funding sources aren’t readily accessible. Bank loans for start-ups and tiny companies dried up several years back. Venture capitalists have lost their appetite for new financing after viewing lots of their high-profile investments — Facebook and Zynga for example — go bad after the firms went public. Investment research firm CB Insights states that lots of start-ups that received seed money will be not able to move to another level — Series A financing. “The process of natural selection that will happen with seed companies, and which we would argue should happen, will lead to over 1,000 recently financed seed firms being orphaned, i.e. unable to increase follow-on funding. This will lead to more than $1 billion of investment in these businesses being incinerated,” according to the company. The section taking the brunt of the funding shortfall will be Internet start-ups since they’ve attracted the maximum proportion of seed money. These are the sorts of organizations that could benefit from equity crowdfunding if it had been available.

Equity crowdfunding is a threat to the venture capital business, at least for the startup segment that requires a small amount of Series A financing. When it might also be a threat to angel investors, a number of them have sought out a cooperative arrangement with emerging equity crowdfunding businesses.

Even though the SEC states that the delay in promulgating rules is because it needs to make sure that prospective equity crowdfunding investors are protected from fraud, the SEC and VC firms have voiced the opinion that non-accredited individuals don’t have any place in the insecure world of investment. In 2013 it is going to be interesting to determine if a federal agency and VC companies can thwart the intent of legislation passed by Congress.

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