In October of 2015, the SEC finalized rules surrounding a new wave of capital formation through equity crowdfunding under the Jumpstart our Business Startups Act (JOBS Act). You can read our full overview of the final rules in a previous post, but here’s the skinny: under the soon-to-be implemented rules, equity-based crowdfunding is no longer saved for high net worth (accredited) investors, and the process for implementing an equity crowdfunding offer is less arduous for small- and mid-sized businesses, up to certain funding limits.
The long-awaited progress of equity crowdfunding, lovingly referred to as Regulation CF, came with as much doubt as it did enthusiasm. Business owners, investors and regulators questioned the impact equity crowdfunding might have on the world of SMEs (small-to-medium enterprises) and how much risk would be involved. Despite these concerns and the uncomfortable stall of initial efforts to move equity crowdfunding to the forefront of SME financing options, as of May 16, 2016, Regulation CF becomes a reality.
Here’s what the launch of new equity crowdfunding rules means for your business:
Alternative funding for SMEs
Commercial loans, lines of credit, venture capital and angel investors all provide viable sources of financing for SMEs. Unfortunately, not every business is adequately positioned to take on certain types of funding to fuel a launch, growth or scale phase. For instance, securing a commercial loan or line of credit through a traditional bank is more challenging than ever, particularly for businesses with little to no collateral to pledge or those with an urgent need for capital. Similarly, venture capital is often reserved for high-growth companies with a strong history of increasing revenues, a category where many SMEs just don’t make the cut. Angel investing is an option for others, but can be difficult to come by during certain stages of business, and may ultimately end up falling well short of total funding needs.
Equity crowdfunding offers a method to secure funding up to certain limits from the public, without going public, for companies looking to launch, grow or scale. With the accredited investor restriction all but removed from equity crowdfunding regulations, investors from all walks of life now have the opportunity to contribute to your SME’s financing needs. Recent reports tout that prior to the JOBS Act implementation, nearly 90% of the population was forbidden from investing in companies through private equity transactions. Under the new rules, SMEs have the opportunity to tap into a substantially higher number of investors, regardless of their level of wealth, income, or accredited status. In theory, meeting financing needs is more of a reality under new equity crowdfunding rules for the right companies, above and beyond what may be available through other channels.
Equity crowdfunding impact
As the Regulation CF rules and implementation came to light, many businesses and investors questioned its viability in the market. Would the increased availability of non-accredited investors provide any sort of noticeable shift in the amount of funding taking place for SMEs? Until companies start utilizing the new rules under Regulation CF, that question can’t be answered with 100% accuracy. But, there is certainly promise in the preliminary numbers.
In late 2015, SeedInvest asked nearly 18,000 non-accredited investors about their ability and desire to take part in equity-based crowdfunding under the finalized JOBS Act rules. The results indicate that smaller, non-accredited investor dollars will make a difference in the financing needs of SMEs. SeedInvest reported that 68% of surveyed investors responded that they were likely to invest in startup companies as soon as it was legally possible for them to do so, while 89% of respondents stated they expected to invest in multiple equity crowdfunding offerings.
Couple these results with the fact that global equity crowdfunding has grown to an estimated $2.6 billion market, and the potential impact of equity crowdfunding becomes much more clear. The demand for equity crowdfunding is not only a legitimate need and want within the confines of private companies; the draw is just as high among smaller, non-accredited investors.
The bottom line
Equity crowdfunding has a certain allure not found with all SME financing channels, but it has yet to be seen if the ideals behind this type of funding will work effectively in practice. Opening up the private equity space to non-accredited investors benefits those offering up funds as well as those on the receiving end, but as with all securities transactions, risks exist for both parties. SMEs need to realize that the new rules for equity crowdfunding do not provide the end-all to financing woes. Instead, equity crowdfunding can be used as an intermediate source of bridge funding or supplemental financing when alternative means are unavailable or fall short.