Almost four years after President Barrack Obama enacted the Jumpstart Our Business Startups Act (JOBS Act), the most highly awaited provision of this act finally came into force in May 2016. Like Canadians, Americans can now contribute to equity crowdfunding campaigns. As is the case in Canada, the practice is however strictly regulated.
What is equity crowdfunding?
Contrary to traditional reward-based crowdfunding, in the case of equity crowdfunding, investors acquire a stake in the company to which they are contributing.
This form of funding enables companies to generally raise more money per campaign; it offers contributors the possibility of achieving monetary returns on their investments over time.
In Canada, equity crowdfunding is governed by two different systems, namely the Start-up Crowdfunding Exemption and the Regulation Respecting Crowdfunding. However, the applicable systems vary from one province to the next.
In the US, the third part of the JOBS Act deals with this type of funding.
As is the case in Canada, equity crowdfunding must be done through registered portals that meet certain requirements. For example, these portals must provide access to educational material that helps investors understand how equity crowdfunding works as well. Investors must also be provided with all campaign documents.
The portals must also provide a discussion forum, obtain the consent of investors and take measures to ensure that investors have fully understood the risks associated with this funding mode. Several such sites have already been approved, including NextSeed,SeedInvest, StartEngine and WeFunder.
Equity crowdfunding for companies
Under American equity crowdfunding rules, companies are authorized to raise up to $1 million.
The documents to be supplied vary according to the amount raised . In campaigns of $100,000 or less, companies are only required to provide their financial statements and certified tax information. With respect to larger-scale campaigns led by companies that have already raised equity crowdfunding in the past, audited financial statements must be provided.
Among the advantages of equity crowdfunding for companies, their investors usually become brand ambassadors and a successful campaign can therefore generate good visibility.
However, this financing method does require companies to make certain investments. According to the US Securities and Exchange Commission (SEC) , companies that launch campaigns to raise US$500,000 or more should expect to pay between US$44,000 and US$54,000 in various upfront costs and between US$3,000 and US$13,000 the following years.
As pointed out in the article titled “Equity Crowdfunding for Cultural Projects”, technology companies that operate in a cultural setting—such as video game studios—are those that will find this method of financing most appropriate.
Equity crowdfunding for individuals
Up to now, private investments in the United States had been limited mainly to qualified investors, i.e., investors possessing the equivalent of $US1 million, excluding the value of their residence, or earning more than US$200,000 per year.
Under an equity crowdfunding model, anyone can invest money in a campaign, but the amount that people can invest depends on their income.
Americans earning annual wages or having assets worth less than US$100,000 are not authorized to invest more than $2,000 or 5% of the lesser of their income or net worth. This limit increases to 10% for people who earn more than US$100,000 per year or are worth more than US$100,000.
In Canada, according to the applicable exemption, it is possible to invest a maximum of $1,500 or $2,500. Qualified investors, however, are authorized to invest more.
Securities regulators limit potential investments to limit investors’ potential losses . After all, 90% of start-ups do not survive their first five years .
Changes on the horizon?
Although equity crowdfunding is only beginning to take off in the United States, a few changes have already been proposed to make it easier to meet the terms and conditions that apply to crowdfunding campaigns.
Indeed, some observers contend that the current rules are too strict and may end up discouraging companies, except as an option of last resort . In other words, only those companies unable to secure another type of financing could be interested in engaging in equity crowdfunding.
Among the solutions that have been proposed , namely by House Representative Patrick McHenry, the SEC could provide measures allowing companies to “test the market,” i.e., to launch a campaign without having to invest any legal fees upfront. The sole goal would be to establish if there is an interest for such a campaign.
The portals could also be made more powerful, and the maximum amount of money collectible could be increased from US$1 million to US$5 million.
Obviously, the level of success generated by the first campaigns should dictate what we can expect in the future. If the SEC adjusts its rules, it will also be interesting to see if Canadian securities regulators will follow suit and adjust their systems accordingly.