This past spring, the Securities and Exchange Commission legitimized crowdfunding as an investment platform. It was once just the darling of small niche projects on sites like Kickstarter and Indiegogo, but when the SEC finalized crowdfunding rules under Regulation A+, it opened investment opportunities to millions of people previously shut out of the system.
Crowdfunding enables startups to answer the $5 million question: Is there a demand for our products in the marketplace? Companies have used crowdfunding to bootstrap everything from watches to board games to major motion pictures. By allowing individuals to pledge small amounts of money to campaigns, startups bypassed traditional investment structures and went straight to their markets.
Those markets now have unprecedented access to investments, thanks to the democratizing effect of the Small Business Jobs Act. That legislation mandated the revised SEC guidelines and paved the way for nonaccredited investors to enter the game.
Barriers to Access
Until recently, regulations favored the United States’ roughly nine million accredited investors, all of whom make more than $200,000 a year or have a net worth of at least seven figures. The SEC shut 200 million nonaccredited investors out of the private transaction market because it considered them unsophisticated, needing protection from high-risk opportunities.
However, this meant that anyone outside of the elite nine million couldn’t make real returns on their portfolios. Declining benefit plans and the projected $14 trillion retirement shortfall created an increasingly precarious situation, especially as private equities continued to outperform public investments. The deregulation of crowdfunding could blow the doors off of the private investment space.
A (More) Open Future
This new access will affect both nonaccredited and traditional investors, not to mention radically alter the way companies secure funding. Investors should be on the lookout for these industry shifts:
The Evolution of Investing:Just as the fintech industry is democratizing the credit and loan space, crowdfunding is forcing lawmakers, investors, and financial institutions to reexamine the status quo. Securing profitable investment returns is one of the only ways individuals can create new wealth, which is vital to growing a strong middle class.
The old regulations gave an unfair advantage to accredited investors. Lawmakers will likely enact more legislation like the Small Business Jobs Act to create more widespread opportunities.
New Options for Non-accredited Investors:Regulation A+ allows non-accredited investors to choose from two investment tiers. Tier One enables companies to raise up to $20 million, and they don’t need to provide audited financial statements and approvals from each state they’ve secured investments in. Tier Two allows for a $50 million raise but throws the audited financial statements back into the mix.
Non-accredited investors can give 10% of their yearly incomes or net worth under Regulation A+. This serves as a good starting point based on institutional investors’ allocations to private equities.
A Different VC Landscape:Crowdfunding platforms will help investors find new companies and will provide startups with greater access to capital. However, the sea of early investors may keep more sophisticated VCs from wanting to give large amounts at later stages.
Rather than focus solely on attracting capital, companies will need to decide what kind of enterprise they are. While they may not be as sexy, non-crowdfunded companies may see large late-stage growth, and the low number of initial investors will make them more attractive to big firms. Not all entrepreneurs want thousands of small investments, so investors should keep an eye out for unique, non-crowdfunded startups as well.
Getting in the Game
Now that smaller investors have a foot in the door, they can advocate for continued progress through smart, ethical decision-making. They can maximize their investments and further change the industry by doing the following:
Taking Responsibility: Smaller investors have the chance to enter the big leagues, but they need to act like it. Those who are new to private investing will inevitably stumble with some ventures. But the worst thing they can do is become overly litigious and outspoken toward regulators. In order to succeed, they must learn from their mistakes and make better choices next time.
Investing Wisely:Institutional investors typically reserve 5 to 15% of their portfolios for private investments, which is a good rule of thumb for newcomers to the private sphere. They should also diversify by putting small bets on a variety of companies, rather than focusing on a few large investments.
Doing their Due Diligence:Professional investors understand companies’ value propositions and why they’re good bets. Individuals should invest in industries where they have specific knowledge or experience, and they should follow professional advice where possible.
The Small Business Jobs Act and SEC rulings altered the playing field for nonaccredited and traditional investors alike. But the principles of smart, ethical investing still apply. Crowdfunding investments carry risks, just as traditional investments do. But these changes mean more wealth creation and access to capital across the board, which makes this new financial terrain worth navigating.
Dusty Wunderlich is the founder and CEO of Bristlecone Holdings, a high-growth network of consumer and business-to-business finance platforms and financial technologies. Its mission is to democratize the world of finance for the better. Dusty is a current recipient of the Twenty under 40 Awards in Reno, Nevada, and is a member of the Young Entrepreneur Council.
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