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Equity crowdfunding is now legal, but don’t expect anything to change just yet

TechCrunch TechCrunch 7/06/2016 T. Alexander Puutio

Equity crowdfunding is now legal in the United States. Four years in the making, Title III of the Jumpstart Our Business Startups Act (JOBS) finally entered into force on May 16. Before this, the masses had access to only what amounts to donations-on-steroids provided by Kickstarter et al., with SEC-accredited investors calling Droit du seigneur ownership arrangements.

The move has been universally welcomed by crowdfunding platforms. In the very first days under Title III, nine platforms — including Wefunder, CrowdBoarders and Indie Crowd Funder — have already registered with FINRA as funding portals that offer equity opportunities for small-scale investors. Needless to say, the crowdfunding scene is about to be disrupted for good.

How equity will change everything…

Ownership matters. Dividends and capital accumulation consistently trump merit and motivation when it comes to explaining wealth inequalities in our society. No minimum wage increase can come close to the cascading effects of a wider distribution of ownership and profits. Equity-based crowdfunding promises to initiate a new cadre of investors for whom ownership has thus far been out of reach.

Equity crowdfunding is great news for startups, as well. Projects such as UNANIMOUS A.I. have already proven how swarm intelligence transforms betting on the Kentucky Derby from a wishing well into a profit-dispensing machine. Funding portals have the potential to unleash this wisdom of the crowds on capital budgeting decisions. Now that’s smart money.

Not everyone is all-in, however. Some argue that hive-minded financing will fail to live up to its hype, because small-scale investors lack the information to make profitable decisions in modern markets. Simple in equals simple out?

Hype and fandom-based activism have served donation-based models well. However, equity is a different animal altogether. Imagine the war over Oculus Rift fought with proxies and aggressive short selling instead of scathing reviews and Reddit threads. Suddenly expectations have a searing downside.

Pessimism is a sure-fire way of avoiding disappointment.

We shouldn’t expect startups to be overly keen to dole out equity either. Previously, crowdsourced financing has gone straight to the left-hand side of the balance sheet, with signed copies and delivery-date promises making for a light-weight liability. With equity comes responsibility. Furthermore, throwing equity in the mix will undoubtedly change the dynamics for later-stage funding rounds, and might even make the company less desirable for high-octane VC.

Regardless of which side of the fence you are on, two things are crystal clear: Equity financing is coming, and it will change how all of us who are $990,999 short of SEC accreditation engage with startups.

…and why that change is yet to come

Title III promises a grand future, which it ultimately fails to deliver. Like the post-financial-crisis era has shown, reform can be a painstakingly long and frustrating process in sectors where deeply vested interests reign supreme. With JOBS, Wall Street certainly did its best to avoid competition.

In the ostensible interest of small-scale investors, JOBS imposes a $2,000 limit on investments made by anyone with an annual income or net worth under $100,000. Similar government efforts to coddling individuals would be frowned upon elsewhere in the financial sector, and absolutely abhorred when it comes to matters of life and death, such as health insurance.

The usefulness for startups themselves is also questionable. Title III limits the amount companies can raise from funding portals to $1 million over any 12-month period. A more serious shortcoming is that companies cannot use special-purpose-vehicles or other trusted intermediaries that facilitate transactions and incentivize fruitful engagement with investment professionals. As a consequence, Title III is making equity crowdfunding riskier than it has to be.

JOBS isn’t all sunshine for startups either. As the amounts raised from the crowds increase, so do the auditing and disclosure requirements. The added burden of having independent auditors scrub through tax returns and delivering meticulously drafted offering statements can easily offset the benefits of crowdsourcing a maximum of $1 million — a sum that is scarcely enough for ambitious startups. Combined with the difficulties of managing a potentially capricious owner base and the stubborn need to raise additional capital from VC, going with equity crowdfunding can be a raw deal for all involved.

A journey of a thousand miles

Pessimism is a sure-fire way of avoiding disappointment. The hopes of many ride on the success of equity crowdfunding, and many are eager to dismiss JOBS and wait for the true savior to come. However fickle legislative progress may be, it is still bound to its ways. Whatever the winds may bring, the democratization of startup investing has set sail with its direction forever forward.

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