A few years back, a friend of mine had an opportunity to get in on the ground floor of a very promising investment…
He was poised to invest $25,000 in Chess.com, a website that teaches players “the game of kings” — and churns out some serious coin while doing so. A $25k investment would have netted him $500,000, an unbelievable return by any measure.
Alas, accredited investor laws prevented him from taking advantage.
In order to be an “accredited investor” you must either make $200k a year, or have at least a million bucks to toss into the ring.
It goes without saying that most individual investors don’t have a cool million to drop on a promising idea. I sure don’t.
And while these rules are supposed to “protect” investors, what they really do is box out everyone but the Wall Street fat cats and Hedge Fund titans.
With so many bright start-ups launching each year, I’d love to be able to get in on the ground floor of something exciting that could deliver twenty times my money, like my friend’s chess wager would have. It sure beats jumping on a bloated, overpriced IPO after the rush of institutional investors.
Well, thanks to last year’s Jumpstart Our Business Startups (JOBS) Act, that time is coming for investors like you and me…
And when the SEC finalizes the legalese, you won’t need to be a millionaire to get in on the next Google or Facebook or whichever “next big thing” is poised to take over our hearts and minds (and wallets).
Currently, crowdfunding is most popular for smaller projects like video games, documentary films, and even good, old-fashioned books.
Websites like Kickstarter have provided a platform for anyone to launch a product into the marketplace by means of public support.
One of the most successful crowdfunding stories is a company called TikTok. In 2010 designer Scott Wilson unveiled a series of wristbands that allowed Apple users to convert their iPods to a wristwatch. It was a simple idea that met a desire for millions of consumers.
Wilson launched the idea on Kickstarter and attracted over 13,000 backers. He had been aiming for $15,000 in start-up costs, but ended up with over a million dollars in funding. Now his products are sold by major retailers all around the world, including by Apple itself.
However, the problem with crowdfunding as it exists now is that there’s nobody to hold accountable if a product falls flat — or never makes it to production.
For example, I recently donated to a Kickstarter project for Kevin Kallaugher, the acclaimed political cartoonist for the Economist. He was searching for the best way to release an old-school, hardcover collection of his best cartoons spanning the last decade. Since traditional methods of publishing left him limited, Kallaugher turned to Kickstarter…
So far, he’s raised over $100,000 — blowing his goal of $20,000 away in the first week. He’s releasing a gorgeous hardback book in color and giving donors signed prints of some of his best editorial cartoons.
Don’t get me wrong; I’m thrilled with the result. But I can’t help but think of the possibilities of my investment netting me cold, hard cash instead of a book… or some sweet dividends instead of a signed print.
Then there’s the notion that if Kallaugher had released a ten-page book of crude black and white drawings stitched together with Scotch tape, I’d still be on the hook for my original donation…
You can imagine the implications for a start-up business if certain safeguards and regulations didn’t exist. The SEC is aiming to add accountability into the mix and actually set regulations on what start-ups would have to divulge and prove before rallying individual investors behind their project.
In addition, the SEC is also trying to toe the line by relaxing the high standards of accredited investor laws to invite more people to the table.
Here’s a rundown of some of the biggest changes:
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“While there are already many types of exemptions, most exempt offerings, especially those conducted using the Internet, are offered only to accredited investors, or limit the number of non-accredited investors who are allowed to participate, due to the legal restrictions place on private placements of securities. Additionally the Bill mandates reviews of financial statements for offerings between $100,000 and $500,000, and audits of financial statements for offerings greater than $500,000 (noting maximum offering of $1,000,000).”
- A new exemption would exist for smaller projects to more easily register for public funding, while attempting to protect beginner investors from their own ruin: “One of the conditions of this exemption is a limit on the amount each person may invest in offerings of this type, according to a person’s net worth or yearly income. The limit ranges from 2% of people earning up to $40,000 up to $10,000 for people earning $100,000 or more.” So while you get a seat at the table now, there is a check in place for those with eyes bigger than their stomachs.
- Regulators will seek ways to protect investor information, require background checks on anyone with more than a 20% share in any project, and require education for individual investors to understand the volatile nature of buying into such small companies.
- The Act will also “raise the limit for securities offerings exempted under Regulation A from $5 million to $50 million, thereby allowing for larger fundraising efforts under this simplified regulation.”
This isn’t just great news for hungry investors, but for anyone dreaming of starting a small business.
According to a recent survey of small business owners, as many as half of small businesses have been unable to secure the capital they were shooting for; almost 40% percent had loans reduced or revoked in the process.
Presumably, if they’d had the option to crowdfund, they could have made up the difference with “unaccredited investors.”
“What I really like about the crowdfunding concept is that the people who are investors in your business are possibly the same people who are customers in your business,” Eric DeSpain of BrainThrob Laboratories Inc. told Entreprenuer. DeSpain has been frustrated with the traditional venture-capital community and is envious of crowdfundings capabilities.
“The fact that you can put your money in something that you really believe in is evidence to me of how capitalism should work.”
We wholeheartedly agree.
The SEC is currently examining the bill, but they may be able to iron out the rest of the details later this year or early into 2014.
We’ll be unpacking the new regulations and laws in these pages as they become clearer.
This time next year, you could be investing like a hedge fund titan…
In the meantime, I’ll be searching for the next Chess.com.
Godspeed,
Jimmy Mengel for The Outsider Club
