SEC Finalizes Key Equity Crowdfunding Rules

I’ve been waiting for this day for 3 1/2 years.

On Friday, the SEC finalized another critical part of the JOBS Act known as “Title III.”

Title III is arguably the most important piece needed to make equity crowdfunding work. I’ve heard it described as Kickstarter plus E-Trade. And it’s been a long time coming. This was supposed to happen by December 2012…

It took a while, but after reviewing the SEC’s final rules on Friday, I think they got most of it right.

Fortunately, they loosened up financial requirements in several key areas. Thankfully, the SEC eliminated the need for full financial audits. There’s more work to be done, but this is a great start.

The new rules will allow smaller, early-stage startups to raise up to $1 million from anyone. Not just wealthy “accredited” investors anymore.

When combined with recently approved Title IV of the JOBS Act (aka Regulation A+), which allows more established companies to raise up to $50 million (from anyone), the future looks bright for equity crowdfunding.

I am convinced that these new equity markets will positively transform the way we invest and how small businesses raise capital.

How do I know this? Because I’ve seen it work.

A form of equity crowdfunding has been around for years, but only for higher net worth “accredited” investors. I’ve personally made over 50 such investments online, and seen the amazing potential in my own portfolio. For examples of success stories, see my past writing on the topic here and here.

Equity Crowdfunding: The Next Megatrend

This is the first major change to U.S. equity markets in decades. Since the 1930s, the vast majority of Americans have been excluded from investing in startups and small businesses.

Now that Title III is finalized, anyone will be able to invest as little as $100 in promising early-stage startups and small businesses.

The first Title III deals should go live in the first half of next year. Title IV (Reg A+) deals will be live sooner. And we’re going to keep you informed every step of the way.

Both startup companies and investors will enjoy unprecedented benefits from this new form of investment.

To understand why, let’s look at the old model of fundraising vs. equity crowdfunding.

Old Model:

  • Raise first money from friends and family, or angel investors if you’re lucky
  • Try to get the attention of venture capitalists (very difficult unless you’re in their network)
  • Rely on traditional methods for sales and marketing

Equity Crowdfunding Model:

  • Raise money from thousands of investors online
  • Benefit from the “value add” of having thousands of shareholders
  • Capitalize on buzz created around the offering

The advantages of equity crowdfunding are tremendous. By itself, the buzz generated by such an offering is almost an unfair advantage for startups. Eventually, hundreds of thousands of people will be viewing these investment opportunities. Everyone is a potential investor, customer and supporter.

Imagine starting a new company with several thousand investors. People who all have a vested interest in helping the business succeed. They’ll make introductions, tell their friends, buy the product and offer assistance any way they can.

Starting a company is hard. Really hard. Equity crowdfunding helps solve two of the primary pain points: raising money and getting people to pay attention.

A startup called Shyp provides an excellent example of the power of equity crowdfunding.

Shyp is disrupting the U.S. shipping industry. For a flat fee of $5, it’ll come to you, pick up the item you want to ship, package it and use the cheapest option to deliver it.

In 2013, Shyp raised money from accredited investors on AngelList. Right out of the gate, Shyp took off. Thanks in part to its crowdfund investors.

Shyp CEO Kevin Gibbons explains [emphasis mine]:

The individuals in our syndicate [crowdfund investors] continue to be among our biggest supporters. Because they’re literally invested in Shyp, they’re a built-in network of advocates, acting like a megaphone on our behalf. Whether it’s sharing our news and milestones, or brokering an introduction in their network, they go the extra mile to multiply our success.

Today, Shyp is one of the hottest startups in the U.S., and currently valued at $250 million. Its valuation was around $7.9 million during its first equity crowdfunding round. That’s a hefty gain for investors in just two years…

It’s important to note that the Shyp deal was limited to 99 individual investors. Title III deals will allow thousands of investors to participate. The positive effects we’ve seen in “accredited” deals will be magnified under these new rules.

This is the power of equity crowdfunding. I’ve seen it happen dozens of times. The effects are real and powerful.

Spread Your Bets Out

The first thing you should know is that investing in startups is inherently risky. Most startups will fail.

Why would anyone invest, knowing this? Because there’s no investment in the world that can touch the potential gains.

Failures are simply an accepted part of the risk/reward equation. So best practice is to invest in a large number of high-quality startups. At least 20, and preferably 50 or more. Spread them out over time, ideally over at least a few years.

Your knowledge will grow with each investment. So I highly recommend starting out with small bets. Then track your investments’ progress using free tools like Owler.com.

If you do it well, the winners will more than make up for the losers. For example, I’ve had two companies in my portfolio fail this year. And I expect more will go belly-up soon.

But the winners have more than made up the difference. My stake in one startup has increased in value 40 times. Others have risen 8x, 6x, 5x. (Note: these investments are not liquid at this time, so the gains are “on paper” only.)

Returns like that are practically unheard of in stocks. But these outliers are exactly what make early-stage investing work.

And soon, we’ll have a product dedicated to helping you find them…

Venture Club

In the next few months, we’ll be offering a service to help investors find the best equity crowdfunding deals. It’s called Venture Club, and we’re hard at work getting it ready for launch.

We’re extremely excited about this project. It’s why Andy and I started Early Investing in the first place. Finally, we’ll be able to offer our research to everyone, not just accredited investors.

Stay tuned as this story develops. Of course, we’ll be covering every major development in this new investment class.

Read more in these recent articles:

Good investing,

Adam Sharp
Co-Founder, Early Investing