The Ripple Effects Of Equity Crowdfunding

The biggest beneficiary of the JOBS Act's new crowdfunding provisions might not be the entrepreneur or the investor, but the investor relations industry.

As the industry evolves,  and "stranger dollars" become more important, investor relations will automatically be necessary for the equity issuer. He is likely to have hundreds, or even thousands of small investors who demand updates once they've put in their money. However, even for the crowd funding portal that "brokers" the deal, best practices would probably be to stay involved with an offering after it closes and continue to give out information about it, much as a broker-dealer does for a public offering. This could all get pretty complex, especially in the beginning.

The SEC regulations are still being written for equity crowdfunding, so many aspects of how the law will actually work are still unknown. Regulatory agencies may make it difficult enough for both issuers and investors that it can't be done without a broker dealer. With rewards or donation-based crowd funding, where investors don't expect a profit, the rules have up to now been a bit more relaxed.
The part we already know is that a small business will be able raise up to $1 million a year through equity crowdfunding starting July 5, 2012--but only through accredited investors and with absolutely no solicitation. That means not online, and not through social channels--yet.
When the entire law takes effect, supposedly January 2013, but probably much later in the year, 
ordinary individuals who make up to $40,000 a year will be able to invest up to $2000 annually in this asset class, and people who make between $40,000 and $100,000 can invest up to 5% of their annual income. Above $100,000, people are considered accredited for purposes of the new law.
For the startup, a.k.a. the "issuer," friends and family rounds are regulated under a different SEC exemption, but if you need a crowdfunded round in the same year that you raise a friends round, it will be limited to $1 million minus what you have already raised. That is, if the SEC doesn't decide to integrate all the exemptions.

The CEO of a startup will also have to certify her own financials. For this reason, a business with traction will have a harder time than a startup raising money. It will probably have to have accredited investors, because it will likely be raising too much money to fall under this law.
And how will the law address finders and brokers? A portal cannot receive a finder's fee, but it can receive a transaction fee. What fee can be charged by a portal? That's not yet clearly defined.

This much-anticipated law, I've determined after listening to about fifteen panelists at the TSL San Francisco Capital Reformation Conference, is not a panacea for the entrepreneur. The crowd controls the conversation. The founder of Tiltpod, for example, has 2500 backers, and says he deals with about 120 email messages a day. And if he doesn't answer fast enough, his investors have fits on his Facebook page.

Moreover, the first dollars still come from close friends. If you don 't already have a social graph or a network, crowdfunding probably won't work for you. First degree networks are very important in crowdfunding, because it is inherently social. According to Danae Ringellman, founder of IndieGoGo, people invest for up to half a dozen different reasons, and only one of them is profit.

People have always raised money from friends and family who invested out of trust and love. These people always want to get capital to you, and with or without a law, they will find a way to make it happen. Right now, they are often doing it illegally with no protections. Crowdfunding will now allow what used to be called "character loans"--you lent or invested in the person, not the spreadsheet. That's why connectivity is important. There's a moral imperative to perform if there's a connection between the giver and the receiver of capital.

Crowdfunding is a case of creative destruction in an unwary and much-criticized industry. The big banks view this opportunity as very small. This is typical of the way old players get disrupted: by smaller, simpler, more nimble players. Banks don't understand the culture of crowdfunding and its social aspects. Donation-based crowdfunding is much bigger now than equity-based crowdfunding, but that will all change next year, because once this law goes into full effect, you will get stock certificates along with your Pebble Watch.
[Image: Flickr user blueforce4116]

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