Empowering the Small(er) Investor and Business: The Potential Impacts of Equity Crowdfunding
In early April 2012, President Obama signed the JOBS Act into law. The goal behind the JOBS Act was to ease federal regulations in order to make it easier for smaller companies to obtain funding. Recently, there’s been a rising interest in the impact of the JOBS Act, focused mainly on “crowdfunding”—which, at least for purposes of this article, refers to the funding of a company by selling small amounts of equity to many investors through online intermediaries.
Title III of the JOBS Act (the crowdfunding portion) allows for companies to raise funds online from a variety of investors, including non-accredited investors. Industry professionals can’t seem to agree on what the impact of crowdfunding is going to be. Today’s post lays out some of the potential impacts for both investors and businesses.
Impacts of Crowdfunding for Non-Accredited Investors
Depending on who you talk to, you’ll hear mixed ideas about the impact of crowdfunding on the investment landscape. One thing is for sure, the barrier to entry for non-accredited investors has been lowered. So one potential impact that crowdfunding will have is an increase in non-accredited investors access to the investment game.
Non-accredited investors will likely benefit from the experience. Most individuals in the U.S. do not fall under the definition of “accredited investor” and, therefore, most individuals have not been able to learn about investing in businesses in the same way accredited investors have been able to—and of those who qualify as “accredited investors” only about 10% actually invest in private offerings. What’s this all mean? It means that the large majority of people know little about investing in businesses. By opening the doors to crowdfunding, many non-accredited investors will learn about investing, including the rights and obligations of a shareholder.
However, minimizing barriers to entry is a double-edged sword. On the one hand, reducing the costs associated with investing will no doubt increase investors’ ability to invest and companies’ access to capital. However, the barriers to entry were created for a reason, to prevent fraud and protect the investor. These barriers have been in place for decades, and lifting them may increase the risk of fraud. Hopefully, individuals who have never invested will take the initiative to learn about investing before diving in. It’s like jumping in a pool before learning to swim. The consequences could be ugly.
Title III does place limits on the amount an individual is able to invest using crowdfunding. These limits are put in place to reduce the amount of frivolous, “uneducated” investing that is thought to occur throughout the non-accredited investor community.
Impacts of Crowdfunding for Businesses
Proponents believe that crowdfunding allows smaller businesses to seek funding that will assist in maintaining operations and pursuing growth. Others believe that the extensive regulations that govern crowdfunding make it cost-prohibitive. The argument is that companies raising funds using Title III of the JOBS Act are required to comply with filing requirements and administrative burdens that are greater than those traditionally required for a private offering under Regulation D. One issue in particular is that under Title III of the JOBS Act, investors can only invest a certain dollar amount over a 12-month period. The issue of how companies keep track of how much an investor has invested if the investments are spread over a variety of online funding platforms is yet to be resolved. One idea is to have an Individual Crowdfunding Account, as suggested by William Carleton in his article last week.
Crowdfunding provides market validation for businesses. You can pitch your business to the crowd to gauge market responses and determine how much people are actually willing to invest in your company. The crowd either wants your business or it doesn’t. Those companies that are successful in raising capital via crowdfunding will likely be more attractive to the market and have a greater chance of succeeding.
For many businesses, the cost of advertising and building a brand is too expensive, especially for very early-stage companies. Crowdfunding offers founders a free platform for advertising their business to investors. Also, companies can develop and refine their brand identity through their pitch. Of course, there are a variety of social media websites where companies can create profiles and tell the world about their business, but these sites are not specifically directed at attracting investors. Crowdfunding platforms are.
Even companies that aren’t successful in raising funds via crowdfunding will benefit from the data they accumulate through the process. This information will help the company evaluate its products and services, pivot (if necessary), and then try again. Starting a business is all about analyzing data, making decisions about how to allocate resources, and adjusting the business to meet customer needs and wants. The crowdfunding process will likely provide a wide range of information for businesses to analyze and, perhaps, make better decisions.