Startup Fundraising Is About To Get A Little More Public
The passage of April’s JOBS Act, a sweeping set of changes to securities laws, brought with it an odd combination of rules. Some, like the ability to file an IPO registration statement in secret, seem contrary to the spirit of fuller and freer disclosure the SEC had been moving toward in recent years. Others, like the removal of the ban on “general solicitation,” move in the opposite direction. Beginning today, startups can tell everyone they’re raising money — which represents a major break from rules that have been in place since the Great Depression. What companies can’t yet do is take money from everyone. But that’s coming, too, once rules on so-called “crowdfunding” are finalized, likely in 2014.
So what happens now?
The general solicitation ban meant that young companies looking for capital had to dance around the rules to actually seek it. Events like meetings of angel investor groups have typically been limited to a few locales in the U.S. and as a result, only a small number of potential investors typically ever sees these companies in their infancy. For the moment, the new rules only affect accredited investors, those with a net worth over $1 million or $200,000 of income, but there are 8.6 million of them, according to Ruth Hedges, CEO of Unismart, who helped guide Congress in the creation of the JOBS Act. “Only about 750,000 currently invest in startups,” Hedges said. “This is going to open up a whole new floodgate of capital to entrepreneurs desperate to raise capital who don’t know angels in Silicon Valley or New York.”
Hedges believes this is true because it will now be legal for companies to take to their websites or YouTube or even a billboard to announce their fundraising intentions. But there are still some severe limitations. The SEC is demanding a filing 15 days ahead of any such activity and requires notifications of whatever the company is up to. It’s also shifting the burden on checking to see if the investor is accredited to the company. Before, it was acceptable to take the investor’s word for it and you could take some money from 35 people who weren’t wealthy. Under the new rules, if you solicit publicly, you have to check everyone out and you’re limited only to accredited types. “You will be penalized if you do not absolutely confirm these people are accredited investors,” she says. The penalty is a one-year ban on fundraising this way.
Still, Naval Ravikant, who runs AngelList and has been matching startups with investors for some time now, took to TechCrunch to explain how important he thinks the rule changes are. AngelList will continue to provide valuable services under the new regime, like accrediting investors once so that companies can trust they meet the requirements for their deal. That kind of streamlining is going to be critical. As the rules currently stand, this new freedom might not benefit many startups since they’ll be forced to ask for significant financial disclosure fromeveryone who invests. Expect others to follow AngelList in providing these services and expect continued push back on the SEC from existing angel investors who don’t like the rules. Ravikant says the Angel Capital Association has been lobbying against the disclosure change but the SEC has turned a deaf ear thus far. (AngelList itself reportedly just raised $24 million at a valuation of $150 million, according to Fortune
Where’s the crowdfunding part?
What really excites Hedges is when the other shoe drops and the SEC finalizes the rules for crowdfunding, the Title III provision of the JOBS Act. That section will allow companies to raise up to $1 million annually from more “regular folks.” Think of it like Kickstarter, but instead of being given the first run of Pebble smartwatches, you’ll actually get stock in the company. Under Title III, the SEC won’t allow people to invest more than $2000 or 5% of their income annually (whichever is greater) if they make less than $100,000 or 10% up to $100,000 if they make more than $100,000, whichever is less. (Those limits can be calculated against wealth or income).
Hedges believes “this is an amazing opportunity” but only for the companies that are prepared to take advantage of. While the rules aren’t finalized yet, which is why companies can’t yet take advantage, it’s clear that companies will not actually be doing this kind of soliciting on their own. Portals will be created to aggregate the efforts of the various companies that will try to raise capital this way. It will be a hybrid of the general solicitation that’s legal today with a Kickstarter-type appeal to the masses. Where before Veronica Mars fans could help make the movie happen in exchange for a signed copy of the DVD, in the future they might share in the box-office receipts.
To help companies see the potential, Hedges is putting on a conference for the second year running in Las Vegas which she calls Crowdfunding Roadmap. It runs from October 14-16 and among the keynote speakers is Tim Draper, the founder of Silicon Valley venture capital firm Draper Fisher Jurvetson. That a high-profile venture capitalist is at a crowdfunding convention might be a bit of a surprise; arguably the masses funding startups might make VC firms less relevant. But realistically, all this ends up crossing over to create new possibilities. A number of Kickstarter projects have ended up as venture-funded companies, including Pebble, and others, like Misfit Wearables, have combined crowdfundingwith venture capital as a strategy to build demand, rather than a means to raise money.
Startup investing has historically been a tight club with little public awareness of what goes on inside it. Beginning today, that changes a little. If Hedges, Ravikant and others have their way, this is just the beginning.