Crowdfunding: How the New Rules Help Small Businesses
Over three years ago, President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act) which, among other things, was intended to make it legal for non-accredited investors to own shares (equity) in companies raising funds through crowdfunding platforms. The goal was to open a vast, new source of capital for start-ups and small business growth.
Since then entrepreneurs have been patiently waiting for the Securities and Exchange Commission (SEC) to approve a regulatory structure for what is known as Title III of the Act. Finally, on October 30, 2015 the SEC approved their regulations receiving rave reviews from small business organizations around the country.
“We are pleased that complete equity crowdfunding can now move forward. Significant gaps in capital access persist, and Title III is an important tool that will bring more investment capital to the table and open opportunities for business owners and entrepreneurs who will never be able to penetrate established investor networks,” explained Karen Kerrigan, President and CEO of the Small Business and Entrepreneurship Council, said in a release.
Wondering what it means to you and your business? Here’s an overview of the current state of crowdfunding and where this latest development fits in.
Rewards-Based Crowdfunding: Crowdfunding first appeared on the Internet as a funding source for small businesses about six years ago. Some of the original sites included Kickstarter, RocketHub and Indiegogo. These sites soared in popularity as an exciting, new alternative to traditional funding options.
To raise capital via a rewards-based crowdfunding site, your company needs to determine the amount of funds you want to raise and create a campaign. Once it’s posted on a site, people can make “donations” to ideas we believe in. In return for your contribution, you receive some sort of gift – nothing more.
One of the benefits of raising capital in this manner is that there very little financial risk. You aren’t burdening your company with debt and you don’t have to worry about satisfying investors. Plus, you’ll have connected to a group of people who are rooting for your success. One of the downsides is that money raised this way is counted as income for tax purposes, so the IRS will typically take a chunk of what you raise.
Equity crowdfunding: Accredited Investors. Individuals with a certain amount of net worth are considered accredited investors. A number of crowdfunding sites have emerged that attract these individuals and encourage them to support start-ups and growing businesses that are struggling to find the capital they need.
Companies are allowed to raise this type of capital based on Title II of the JOBS Act. The SEC passed a new exemption called Rule 506(c) of Regulations D. (Don’t you love all the jargon?) This rule provides that fundraisers agree to verify that all investors involved in a campaign are accredited. Think of this as angel investing with an online component. Investments are typically larger than with rewards-based programs.
Equity Crowdfunding: Non-accredited investor. This is the most recent evolution in crowdfunding. The SEC notes that its new regulations are intended to help alleviate the funding gap and accompanying concerns faced by start-ups and small businesses in connection with raising capital in relatively low dollar amounts. A complete overview of the regulations is on the SEC website.
Peer-to-Peer Crowdfunding. It’s also important to mention peer-to-peer crowdfunding, which is a form a debt financing. Think of this as online dating that matches prospective individual lenders with individual borrowers. Generally, the loans are unsecured. Prosper is one of the most popular P2P sites. According to its website, it has more than two million members and has funded over $5 billion in loans. Loan requests range from $2,000 to $35,000 and members can invest as little as $25.00.
Alternative finance solutions are undoubtedly improving for small businesses. That being said, most small business start-up capital comes from personal savings, credit cards or family and friends. But if you’re looking for ways to start or expand your small business, don’t overlook these alternative sources.