It's official. After years of law-making, regulation-writing, and tweaking of the fine print, equity crowdfunding is about to become "a thing."
For years, websites such as Indiegogo and Kickstarter have helped us to help others bring new products to market. Through contributions of $100, $50, or $10, a consumer might support a new company in exchange for a first edition of a new product, a t-shirt, or...an emailed note of hearty thanks. One thing small investors like you and I were not able to obtain through Kickstarter, though, was a piece of the company that makes the product.
Simply (if cynically) put, these companies were happy to take our money, but all we got in exchange was a "I Gave Kickstarter $50, and all I got was this T-shirt" T-shirt.
That changed last month.
Putting the JOBS Act to work
Last month, the Securities and Exchange Commission finally published the rules for "Title III" of the 2012 Jumpstart Our Business Startups Act, or JOBS Act. Beginning sometime early next year, privately owned start-up companies will be permitted to raise up to $1 million annually by selling shares directly to small investors through a process called "equity crowdfunding."
At the same time, we investors -- previously locked out of this pre-IPO market -- will be permitted to invest, in ascending order:
- $2,000 annually, spread across as many crowdfunding investments as we like.
- Or 5% of the lesser of our annual income or our net worth, if that works out to more than $2,000.
- Folks who both earn more than $100,000 annually and have $100,000 or more in net worth may invest 10% of the lesser of annual income or net worth.
The SEC plans to begin registering "funding portals" -- the JOBS Act equivalent of the online brokers where you can buy and sell publicly listed stocks -- on January 29, 2016. And a few months later, probably as early as next summer, the floodgates will open on equity crowdfunding.
How will it work?
From an investor's point of view, the first step in equity crowdfunding will probably consist of logging onto a funding portal and buying shares in a start-up. According to KoreConX, a new company that is itself aiming to facilitate the process of equity crowdfunding, the biggest portal names today are Offerboard, CircleUp, SeedInvest, Agfunder, MicroVentures, Seedrs, and Folio.
Few of these companies are household names (at least, not yet). Folio appears to be the biggest player in this nascent industry -- you may know it by its more common name, FOLIOfn. Folio is also, incidentally, a KoreConX partner.
With those two factors in its favor, Folio may be a good portal to bookmark if you want to experiment with equity crowdfunding next summer.
Buying shares in a private, pre-IPO company will be only the first step, however. KoreConX CEO Oscar Jofre warns that while some companies are doing "cap table management," and some portals will be "managing the investors with investment" themselves, the process isn't yet seamless. Difficulties could crop up as investors and the companies seeking investment -- and the portal themselves -- try to keep track of who owns what, and who owns how much.
Indeed, with as many as 225 million new investors potentially flooding into the private equity market next year, hiccups are almost certain to occur. KoreConX is rolling out what it calls an "all-in-one solution" to manage communications among "investors, issuers, portals" from the time of first solicitation, through investors putting money in the start-up, to "ongoing reporting" of how the investment is performing over time.
All of this sounds promising. But the early days of equity crowdfunding are still likely to be hectic and confusing for all involved. It may sound perverse to say this about a new development, and particularly one that's designed specifically to open up private equity investment to "the little guy," but the best advice I can give to small investors at this early date is to let somebody else play guinea pig with this system. The less money you devote to equity crowdfunding, the less money you're able to lose while the kinks are being worked out.
Put another way -- sure, with Kickstarter your investment may win you nothing more than a T-shirt. But with a Kickstarter investment, at least you won't lose your shirt.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on our virtual stockpicking service, Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 299 out of more than 75,000 rated members.
The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.