Huge Potential for Social Enterprises: Equity Crowdfunding

Posted admin Crowdfunding, Public Policy

Huge Potential for Social Enterprises: Equity Crowdfunding

By Tom Triplett, SEA-TC Board Member and Chair of the Public Policy Committee   

Tom Triplett

On October 23, the federal Securities and Exchange Commission (SEC) issued proposed rules on what is called “equity crowdfunding.”  When fully implemented in mid-2014, this new investment tool will provide a potentially huge source of start-up and expansion funding for social enterprises.

“Donor crowdfunding” got its big start with then-Senator Obama’s 2008 presidential campaign.  News media reported that by the end of the campaign, Obama’s internet funding efforts were generating $1 million per day in donations, with the average contribution less than $100.

More recently, major crowdfunding intermediaries like KickStarter, Indiegogo, and RocketHub have generated hundreds of millions for a broad range of start-up enterprises.  But instead of getting an equity position in the venture, donors only received swag like a t-shirt, a new band’s CD, or a copy of a new indie film.

All this is changing with the proposed new SEC rules.  What’s the biggest change?  Now “donors” can become “investors” in new enterprises.  Rather than the t-shirt, investors can receive an equity stake in the enterprise or in other cases become a lender.

President Obama signed the Jumpstart Our Business Startups Act (JOBS Act) in April, 2012.  The Act directed the SEC to adopt rules for the Act’s equity crowdfunding component by January, 2013.  The agency was delayed in issuing the rules largely because of their complexity and other rule-making tasks delegated to the agency – e.g. many provisions of the Dodd-Frank banking overhaul legislation.

The new crowdfunding is not limited to social enterprises.  Any for-profit venture could attempt to generate equity funding through the new tool.  However, because crowdfunding seems to appeal to the type of individual likely interested in social-value-based enterprises, I anticipate that for-profit social enterprises will be big winners with this new financing tool.   

While many start-up enterprisers are undoubtedly salivating at the new funding tool, so are fraudsters.  Warning bells are already being wrung by consumer advocates.  AARP in its October-November magazine sees the new funding tool as one more way for fraudsters to scam its members.  AARP fears “con artists cold-calling with bogus offers from crowdfunded start-ups.”  Worst of all, from our perspective, would be a scammer claiming to be a social enterprise!

The SEC rules deal with the fraud potential in two primary ways.  First, lower income investors (with less than $100,000 in income/net worth) are limited to investing 5% of their net worth/income or $2,000, whichever is greater, in all such ventures in a given year.  For those with more than $100,000, the limit is 10%.  The enterprises themselves can raise no more than $1 million using the tool.

Second, the proposed rules require the use of intermediaries or registered brokers; the start-ups themselves cannot directly approach crowdfund investors.  The feds hope that intermediaries and the fees they charge enterprises will weed out the scammers.  Presumably, the KickStarter-type portals will rush to fill those intermediary roles, but hopefully more locally- and social-issue-based intermediaries will also seek to become approved intermediaries.

There are other limitations too.  For example, SEC-proposed background checks and other pre-solicitation requirements will impose up-front costs that may limit fraudsters (but also may inhibit legitimate enterprisers).

The proposed rules cover 592 pages (!) with the SEC asking for comment on 295 specific questions relating to the rules.  Undoubtedly the final rules will vary from the proposed ones. So, bottom line, equity crowdfunding is on its way, but the details are in flux and will be for some time yet.

See http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540017677#.UnESyVko6Uk for background materials and http://www.sec.gov/rules/proposed/2013/33-9470.pdf for the proposed rule itself.

 

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