The idea of crowdfunding has now reached the investment world, with new rules in effect as of May 16 that make it possible for small businesses to raise as much as $1 million in a 12-month period from investors.
Crowdfunding, highlighted by the success of sites like Kickstarter, has helped to finance everything from movies, videos and artwork since its creation in 2009. The Kickstarter website says more than $2.4 billion dollars in money has been raised to successfully finance nearly 106,000 projects. But Kickstarter funders don’t get pieces of a company in return.
Now, as a part of the 2012 JOBS Act, the question to be answered is how successful crowdfunding will be in raising equity for small businesses.
This new investment opportunity comes with a number of rules by the Securities and Exchange Commission that regulate the amount of money an individual investor can risk as well as the information that small businesses must disclose before receiving any crowdfunding revenue. In addition, all investments are limited to funding portals approved by the SEC.
If an investor has income or net worth that falls below $100,000, she can only invest $2,000 or 5 percent of annual income or net worth – whichever is lower – in a 12-month period. Investors with income and net worth above $100,000 can put up more money – up to 10 percent of annual income or net worth, whichever is lower.
If your company is working on the next great idea for the next mobile app, or your fledgling technology company needs seed money for testing, you will need to spell out the financial condition of your company and how you plan to use any proceeds from crowdfunding. That will greatly increase legal and accounting costs. The funding portals will also take a cut.
Investment experts warn that while some investors may find success buying shares of fledgling companies, the risk involved is great and investors should not put up any money they cannot afford to lose.
How will investors make money? Experts say it won’t happen immediately. In fact, the rules require that any crowdfunding shares that are purchased cannot be sold for at least a year. Most likely, an investor would make money if the business was acquired by a larger company or goes public in a traditional IPO.
Check out these crowdfunding sites approved to handle equity sales: