Crowdfunding sites prepare for equity-based investments
When Congress passed the Jumpstart Our Business Startups Act in April, it allowed young companies for the first time to sell stakes of their businesses to large numbers of investors — a practice called equity-based crowdfunding. But before startups can take advantage of this provision, the Securities and Exchange Commission must outline rules for exactly who can invest and how much they can contribute to each venture.
The SEC is planning to announce the regulations by the end of the year, and the Financial Industry Regulation Authority will likely follow with its own set of rules.
The prospects for equity-based crowdfunding have led several companies to set up Internet crowdfunding platforms — “intermediaries,” according to the SEC — which connect potential investors to new businesses. Here’s a look at what some of them are doing while they wait for the rules to be formalized:
The fundraising platform Kickstarter may be one of the best known, but the company does not plan to move to an equity-based model, perferring its perk-based system, where people can seek small amounts of money in exchange for perks such as invitations to premiers or film credits. That creates an opportunity for a competitor such as Indiegogo,which intends to allow users to sell stakes when the rules are clear.
In the meantime, Indiegogo has been focusing its efforts on building its own community of users, chief executive Slava Rubin said.
As equity-based crowdfunding becomes more viable, Rubin said Indiegogo anticipates several new platforms cropping up in both the perks and equity based crowdfunding sectors.
“It’s going to be a little bit like the goldrush, with everyone thinking they’ll be able to capitalize on these laws,” Rubin said. But Rubin added that he supported equity-based crowdfunding in part because of its potential to create jobs.
In fact, Indiegogo has even made it possible for a potential crowdfunding competitor to get funded — “it’s a completely open platform, and it works within our philosophy,” Rubin said. With so many more funding sites, entrepreneurs will need to think more carefully about which platform to use, he explained.
To give Indiegogo an edge over the new crop of competitors, Rubin plans to develop educational guides for users so they can understand both perks and equity based investing and do his best to ensure that people come to Indiegogo with high quality campaigns. The site will also focus on supporting artists and entpreneurs through the campaign process, and feature testimonials to draw new entrepreneurs and investors. Most importantly, Rubin plans to beat out the competition by “gain[ing] the trust of customers” — this means keeping the platform clear of fraudulent activity and money laundering, he explained.
Navy reservist Lt. Marlon Terrell recently launched RepayVets, a Laurel, Md.-based crowd-funding site poised to help military veterans start businesses. Like Kickstarter and Indiegogo, RepayVets currently uses a perks-based model, but is limited to projects brought by veterans or servicemen. While the site has funded a handful of projects using the donation-based model — including a piece of athletic equipment manufactured and designed by a veteran — Terrell thinks equity-based crowdfunding will be essential to the success of his business and the ideas of his customers.
“Military members are not going to get as much service from the [donation] process because the type of businesses they have aren’t built for that. They don’t have as many products,” he said.
Perks-based donations tend to be much more useful for people creating discrete projects, whereas businesses can better use equity investment, Terrell said. He expects significantly more traffic to his site once equity investments are allowed.
In Terrell’s experience, the ratio of business to product pitches is about 80 to 20 percent.
“There is no lack of veteran entrepreneurs, but there is a shortage of the ones who have a real product,” he said.
Instead of developing a perks-based model, crowdfunder is using the interim period to lay the foundations for social networks before it plunges into equity-based crowdfunding.
While waiting for the regulations, startups are using the platform to raise social capital — or building and accumulating personal relationships— which could eventually lead to investments. Crowdfunder has registered 8,000 investors with $17 billion in potential investment capability and 4,000 founders with specific fundraising goals — these investors and founders are encouraged to connect with each other before the regulations are released. Both investors and founders can make profiles based on their interests, fundraising goals and ideas.
Chief Strategy Officer DJ Paul has been meeting with the SEC and is on the board of the trade assocations Crowdfund Intermediary Regulatory Advocates and the Crowd-funding Professional Association. Having interacted with other nascent crowdfunding platforms, Paul noticed that many don’t consider crowdfunding to be as closely tied with the securities industry as it actually is, he said. Some also may not have fully considered the costs of operating as an intermediary, which involves a lot of compliance-related expenses.
Unsuccessful platforms will likely fail because of a “cultural problem”, he predicted. Some people — mostly from the East Coast — are entering the crowdfunding industry from a securities background, while many more — mostly from the West Coast — come from the tech world. The most successful crowdfunding intermediaries, he says, will be the “happy marriage of those cultures – most are in one side or the other of those cultures.”
Though funding portals like crowdfunder are explicitly forbidden from giving out investment advice, another factor determining a platform’s success will be the ability of users to share investment advice with each other, said chief executive Chance Barnett.
“The direction of crowdfunding is hinged on people’s physical networks, not virtual ones” — because people are likely to support the businesses of people they know and trust, Barnett predicts.