Sunday, December 6, 2015

Tech Startup Crowdfunding Isn’t All It’s Cracked Up to Be. (High-growth firms face powerful disincentives to use JOBS Act provisions)

Allowing everyday Americans to invest in today’s high-growth startups—picture grandma and grandpa putting a portion of their retirement savings into the next pre-IPO Facebook —has long been the dream of advocates of so-called equity crowdfunding. This dream was supposed to be enabled by the Jumpstart Our Business Startups Act, which became law in April 2012. Three years later, after substantially more wrangling than anyone anticipated, Title III of that act is finally codified as rules written by the Securities and Exchange Commission. According to those rules, as of May 16, the floodgates of equity crowdfunding will be officially open.

Imagine if all the people who backed the Oculus Rift VR headset—which raised $2.5 million on crowdfunding site Kickstarter in 2012 and was sold to Facebook for $2 billion in 2014—had gotten a piece of the company, instead of just early access to its headsets. ​​

But if you talk to people building startups around equity crowdfunding, you’ll discover an open secret: As a mechanism for funding startups like Oculus, it is basically a nonstarter.

This is apparently deliberate. The SEC, responsible for creating the rules designed to fulfill Congress’s mandate in Title III of the JOBS Act, included rules—known collectively as the 12g rule—that are a powerful disincentive for high-growth startups to use what the SEC calls “regulated crowdfunding.”


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These rules stipulate that any company that takes on more than 500 individual investors or grows to a size greater than $25 million in assets must start filing regular disclosures just like a publicly traded company. It is all the pain of an IPO without the benefits of the IPO
“When you say the SEC was putting in things to make sure equity crowdfunding isn’t used for high-growth startups, it’s these rules that are the killer,” says Kevin Laws, chief operating officer of AngelList, a portal that currently allows only accredited investors—generally those with a net worth of more than $1 million—to link up and invest in early-stage startups.

These​ new​ rules also limit the amount that any individual can invest. If you have less than $100,000 in annual income or net worth, each year you can only put $2,000 or 5% of your net worth or income, whichever is less, into crowdfunded startups.

“Given the disclosures that are required, I doubt a lot of tech companies are going to want to use regulation crowdfunding,” says Erin Glenn, head of Quire, one of the startups that hopes to enable businesses to raise money through regulation crowdfunding. Instead, says Ms. Glenn, she sees small and local businesses—think of coffee shops and hair salons—using equity crowdfunding and peer-to-peer lending, which is also enabled by Title III, to gather funds that in times past might have come from a community bank.

Some are still determined to bend the SEC rules into a shape that will allow them to be used for tech startups. One such portal is Wefunder. “There’s the intent of Congress versus what the SEC wrote,” says Nicholas Tommarello, founder of Wefunder. Mr. Tommarello is confident he has found a workaround that means all kinds of startups, including tech startups, will be launching on Wefunder soon after the May 16 date on which the SEC rules go into effect.

“One way to get around this is a broker dealer can hold all the securities ‘in street name,’ which counts as one shareholder of record for purposes of the exchange act,” says Mr. Tommarello.


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If Mr. Tommarello is right, or if subsequent legislation from Congress clarifies or expands crowdfunding, it is possible at some point we’ll still arrive at the original vision of equity crowdfunding, which is giving everyday people access to high-risk, high-reward assets. “Our entire brand is, this is a lottery ticket,” says Mr. Tommarello. “My attitude is, you can go to Vegas or you can put it in a startup.”

The problem with that attitude, says Charles Moldow, a partner at venture-capital firm Foundation Capital, is that “the idea that a nonaccredited or even accredited investor is going to somehow be successful at early-stage venture capital strikes me as challenging.”

The worry, voiced by many, is that the pool of startups using equity crowdfunding will consist mostly of lower-quality companies that couldn’t get funding by other means.

It’s also true that, while it might not be appropriate for most high-growth tech startups, equity crowdfunding will almost certainly be huge for some startups as a type of marketing, and a way to demonstrate market interest to traditional investors. It is similar to how ​companies on​“traditional” crowdfunding sites such as​Kickstarter and Indiegogo​demonstrate interest in their products today.

The next Oculus might not launch on an equity-crowdfunding platform, but it might offer some shares in the company as a way to stoke interest. Given the number of restrictions put on equity crowdfunding, though, it certainly seems as if good old-fashioned crowdfunding—with virtually no screening of companies or their finances—is the most likely place for early-stage companies to find that kind of support.

The current regulations, as written, seem almost draconian in their cautiousness. If you’re worried equity crowdfunding could yield the 21st-century version of penny-stock pump-and-dump schemes, that’s a good thing. But if you think that attitude is patronizing, there is always the chance that the SEC’s rules might someday be judged by Congress to be contrary to the original intent of the JOBS Act. ​ ​

Whatever rules finally get us “Kickstarter but for shares in a company”—and whether that is even a good idea—is years away from being sorted out.

Disclaimer :- Following article come from WSJ