By Cliff Ennico
As I’m writing this, the U.S. Securities and Exchange Commission (“SEC”) is preparing to hand down final regulations allowing startup companies to use “crowdfunding” techniques to raise capital, for the first time in U.S. history.
In last week’s column, I talked about the strengths and weaknesses of the SEC’s proposed crowdfunding regulations, in an attempt to figure out if “equity crowdfunding” (raising capital for your startup or small business using crowdfunding techniques) will revolutionize the capital raising process in the United States.
The short answer, sadly, is “no”. To ensure that investors who are neither wealthy nor sophisticated don’t get “fleeced” by bogus startups, the SEC has built in a large number of safeguards which I predict will make equity crowdfunding both expensive and time-consuming, especially for “concept” startups (those with merely an idea for a business, product or service that are looking for funds to build a prototype or test their business plan).
Lest my readers despair, however, there is one aspect of the proposed equity crowdfunding scheme that is truly groundbreaking, and which has the potential to revolutionize at least one corner of the securities industry.
That aspect is Title II of the federal Jumpstart Our Business Startups (JOBS) Act, relating to offerings made by general solicitation and advertising to “accredited investors” only, which I predict will totally transform the “angel investor” industry.
Traditionally, “angel investors” – wealthy “millionaire next door” type individuals who provide capital and advice to startup and very early stage companies – are an isolated bunch of loners. Most often their investments are purely local, to companies based in their home town or county. The most social of them belong to an “angel club” consisting of not more than 10 people who meet once a month at the local country club.
They are often ignorant of investment opportunities in other states (or countries), or industries in which they lack personal experience either as an investor or as an executive in corporate America.
Over the last 100 years, venture capitalists and others (including my colleagues and I when we launched the “MoneyHunt” television show on PBS almost 20 years ago) have dreamed of creating a “portal” to help isolated angel investors around the country identify the most promising startups, no matter where they were geographically based or what industry they were in.
The proposed regulations would allow websites such as AngelList (http://angel.co) to set up “angel portals” dedicated to “accredited investor only” offerings. These websites would include startups to reach out to investors via general solicitation and general advertising methods, thereby making angel investment possible for scores of startups – including “concept” companies” — that are currently off investors’ radar screens.
Even better, Title II crowdfunding will enable these websites to build up a database of qualified “accredited investor” angel investors that they can share to find the perfect “fit” for a particular startup or entrepreneur.
The only sticking point in Title II crowdfunding is that if a startup company allows even one non-accredited investor into the fold, it blows the entire offering and requires the startup to register a “public offering” with the SEC. Not a good result.
So how do startup company founders, with lots of friends and family but few contacts with “one percent” investors, get up and running under the proposed SEC regulations?
One thought that occurred to me (and, to be fair, other commentators on the proposed SEC regulations as well) is that an early-stage company might want to launch two offerings simultaneously:
a Title II crowdfunded offering of preferred shares to “accredited investors” for most of the money they need to grow; and
an “equity crowdfunded” offering of common shares for non-accredited investors such as friends, family, customers, and other people sourced through the Web who do not qualify as “accredited investors”.
I call this an “Upstairs/Downstairs” offering, with apologies to a popular BBC television program that aired on Public Television in the United States in the 1970s.
Looking at the longer-term picture, crowdfunded investments have a potential to become the “norm” for private equity investment in early stage companies. The people who promoted equity crowdfunding were absolutely right in pointing out to Congress and the SEC that investors today are a lot more “savvy,” and have access to lots more information (literally) at their fingertips, than investors in early 20th century America could even imagine, and therefore don’t need the extensive protections required by laws that date back to the 1930s.
It’s just that I think it will take longer to get there than the current wisdom says it will. Change, especially in an industry so tradition bound and cautious as the securities industry, only happens slowly and incrementally. It will take longer than a few years for the industry, and their regulators, to accept the hypothesis that the “crowd” knows more collectively than the individuals within it.
Then again, I could be wrong. We’ll see.
Cliff Ennico ([email protected]) is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. Copyright 2013 Clifford R. Ennico. Distributed By Creators Syndicate, Inc. Follow Cliff: @cliffennico.