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Leadership

Today Is A Historic Day For Startup Investing, And Some Entrepreneurs Are Worried

Despite the headlines, some people think the new SEC investing rules may do more harm than good.

[Photo: Flickr user Myfuture.com]

Today is a big day if you are hoping to become a wealthy venture capitalist. The SEC has enacted new rules making it possible for nonaccredited investors to invest their money in early-stage startups. This means that people making less than $200,000 are now able to use online investing platforms to bet on companies they think could hit it big, which has never before been possible.

At first glance, this seems to mean that ordinary people like you and me could invest in companies like Facebook before they became Facebook. It turns out that’s not exactly the case, and it’s causing some within the venture capital world to pause at what these new rules could bring.

To understand why, it’s important to understand what these early-stage companies must do in order to qualify to receive nonaccredited equity funds. It’s written in the fine print of the 600-plus pages of Title III of the Jumpstart Our Business Startups Act (the JOBS Act). Fast Company’s Sarah Kessler wrote a great explainer about what these changes mean and what companies can participate. But complying with these rules is easier said than done, say some critics. And many of those who’ve been keeping tabs on this issue fear the new rules may do more harm than good.

Alex Mittal, cofounder and CEO of the online venture capitalist fund FundersClub, believes that the Title III rules going into effect today put in place safeguards that are prohibitively costly to the companies hoping to receive funds. The big issue is that the startups seeking to dole out equity are given excessive burdens to overcome; these rules set out by the SEC are stricter than what other companies do when seeking out angel or seed rounds from normal investors. These new rules, says Mittal, "mandate a higher level of disclosure," which will likely take many early-stage startups out of the running since they are unable to comply. More, they incur higher costs when complying with these rules.

For example, the SEC requires what are known as GAAP financials, which is a practice for maintaining business financials that requires at the very least the assistance of a trained accountant. When investing with accredited investors, this is not required. As Sheri Atwood, CEO of the expense tracking app SupportPay, told Fast Company, when a company is raising seed or angel funds from accredited investors, all you need to do is "be able to show a business plan and your product." Now the startups looking to crowdfund with these new SEC rules would have to pay out of pocket to prove all their financials are in order.

Ultimately, critics of Title III see two big problems. One, the rules mean that only a certain subset of companies unable to receive funding from traditional sources can participate. "It naturally selects from the most desperate companies," says Mittal. If they were able to get a VC on board or have the help of friends and family, there’s no way they’d jump through these SEC hoops.

This leads to the second problem, which is that nonaccredited investors are only able to participate in rounds for this certain kind of startup. Says Mittal, the companies likely seeking these nonaccredited funds are being pushed against a wall. He believes that instead of expecting companies to provide these sorts of expensive safeguards, the SEC should put into place ways to ensure that nonaccredited investors truly understand the risks they’re incurring. That way more companies can participate without paying tens of thousands of dollars in accounting and disclosure fees, and there’s a heightened level of protection in place.

Those in favor of the new changes have a different perspective. "I would say that this will matter for businesses outside of Silicon Valley that don’t have access to abundant capital," says Ryan Feit, CEO of the equity crowdfunding platform SeedInvest. In his view, there are a great deal of companies that simply don’t have the networks to make the right connections. Title III makes it possible for a "Main Street business" to get venture funding.

Still, its critics see the new rules only making the Wild West venture funding even wilder. Today is the first day—we have a while until the effects are truly known. But if you think this means you will be able to be part of the next big thing at the ground floor, well, that’s easier said than done.

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