In Defense of Following the "Crowd"

“For the first time,” said President Obama back in April 2012, “ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”

Obama was referring to an historic piece of legislation called the JOBS Act, short for Jumpstart Our Business Startups. He was thrilled about it and champing at the bit to get it out into the world.

On Oct. 23, 2013 — after 15 months of delays and 500 pages of rules! — the U.S. Securities and Exchange Commission (SEC) finally caught up to him. They proposed regulations that will allow any individual to make small investments (as little as, say, $100) into a startup and in exchange receive a share in the company. They call it “equity crowdfunding.”

Here are two reasons why this is such a “hallelujah!” moment:

1) It really is heartwarming to invest in entrepreneurs you believe in.

2) Investing in private companies when they’re still in their earliest stages can be insanely lucrative. The backers of companies like Google, Facebook and Instagram became fantastically wealthy.

That said, this is risky territory. First of all, to get involved, you need to follow the SEC’s special guidelines. Some of the rules are set already; others are coming early next year. Second, investing in private companies is different than buying stocks or mutual funds — for one thing, it’s easy to lose your shirt if you’re not prepared.

Today we’re going to tell you what you need to know…

Equity crowdfunding — or in the fancy official language, Title III of the JOBS Act — allows startups to raise small amounts of capital from a large number of ordinary citizens. Although the SEC might tweak a rule here or there in its final set of regulations, here’s how the various participants in equity crowdfunding will be ordered.

For investors:

If you have less than $100,000 of annual income or net worth, you can invest $2,000 per year in equity crowdfunding deals, or 5% of your annual income or net worth (whichever is greater).

Example: An investor earning $80,000 per year can invest $4,000 ($80k x 5%) per year into equity crowdfunded deals.

If you have more than $100,000 of annual income or net worth, you can invest 10% of your annual income or net worth (whichever is less) into crowdfunded deals each year. The limit is $100,000 per year.

Example: An investor with an income of $300,000 and a net worth of $500,000 can invest $30,000 per year ($300k x 10%) into equity crowdfunded deals.

For startups seeking to raise money:

Certain companies are not eligible for equity crowdfunding — for example, companies that have acted badly in the past (this rule aims to protect you by keeping frauds out of the system) or public companies.

Companies that are eligible must provide documents that help us get a better look “under the hood.” These documents include:

• Income tax returns
• Standardized financial statements, as well as a written summary from the CEO
• Depending on how much the company is raising, their financials must be certified:
  • If less than $100,000, the financials can be sworn to by the CEO<
  • If between $100,000-500,000, the financials must be certified by a CPA
  • If over $500,000, the financials must be audited by a “big” firm.
• Exactly what the company proposes to do with the capital its raising
• Full discussion of potential risks for investors.

For crowdfunding portals:

There’s a new type of SEC-registered intermediary known as a “funding portal.” This is the middleman that matches startups with potential investors online. There are dozens of these portals setting up shop already (www.AngelList.co and www.CircleUp.com are two you may already have heard of), but it’s expected that soon, there will be hundreds.

The huge number of portals — and the huge number of “deals” on each — is why my cofounder Matthew Milner and I launched www.crowdability.com, and newsletter.

We aggregate all the equity crowdfunding opportunities into one place and then add some education and insight around them. We also write white papers and special reports to inform investors about risks and opportunities.

All these portals must register with the SEC. They’re legally on the hook for fraud, and they’re not allowed to recommend specific deals.

The funding portals must follow certain protocols, including:

• Verify that the startup has an accurate way to track things such as the owners’ addresses, share transfers, etc.
• Confirm that investors have been educated about certain risks
• Disclose their compensation for each deal
• Provide a way for potential investors to communicate with each other and with the staff of the startup — for example, an online message board.

The final rules from the SEC will arrive early in 2014. To ensure that you’re on the right side of the law, we invite you to visit us at www.crowdability.com.

We’ll continue to keep you up to date on the legislation, teach you how to diversify your startup investments and even entertain you by highlighting interesting opportunities — like flying cars!

Regards,

Wayne Mulligan
for The Daily Reckoning

Ed. Note: The investment implications that accompany equity crowdfunding are truly astounding. To think… You could safely and easily invest in the next Google or Apple before anyone else has even heard about it. That’s pretty incredible. And it’s only going to get better. To stay one step ahead of the curve on this developing story, sign up for The Daily Reckoning, for free, right here.