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What You Need to Know About the New Equity-Crowdfunding Model

September 19, 2013

In her book Cash From the Crowd, Sally Outlaw, founder and CEO of crowdfunding website peerbackers, reveals the secrets of funding your business with help from colleagues, peers, family, friends and even perfect strangers through a crowdfunding campaign. In this edited excerpt, the author provides information on the new equity-crowdfunding model that was authorized by the JOBS Act of 2012.

Until now, crowdfunding has come from backers who donate money with no expectation of a financial return, but that's about to change. The JOBS Act, which offers the first changes to securities law in more than 80 years, enables a new equity-crowdfunding model that allows backers to buy shares in posted ventures. Entrepreneurs who list on equity-crowdfunding platforms will have an opportunity to raise serious capital and must also manage new expectations, responsibilities and obligations to regulators and shareholders.

Under the new law, a company seeking money from "the crowd" may sell up to $1 million in securities in any 12-month period to an unlimited number of investors via a Securities and Exchange Commission-approved crowdfunding platform. Although right now, only accredited investors can purchase these securities, the general public will have the same opportunity when the SEC implements its new "Crowdfund Investing" rules in 2014.

Related: The Basics of Crowdfunding

One of the toughest aspects of this new direction for crowdfunding may be the work involved with managing the expectations of hundreds of new investors. Most of the public, who have never had the chance to invest in a private company, may expect a financial return faster than is the norm in the startup world. Many backers involved in the current donation model of crowdfunding can be demanding as they wait for overdue "rewards" to be shipped; that persistence may be magnified if they're awaiting a dividend check. Even if backers fully understand the risks of investing in crowdfunded startups, they'll certainly be expecting -- and entitled to receive -- frequent updates and financial reports. The investor-management piece of this equity equation will be a challenge for entrepreneurs.

First, the Facts
The good news is entrepreneurs will be allowed to sell up to $1 million in securities through this crowdfunding method. The bad news is there are numerous requirements, restrictions, and liabilities.

Although the rules and requirements weren't yet finalized as of this writing, it looks like entrepreneurs looking to crowdfund via the equity model will be required to make at least the following information available to the SEC, to the platform through which they raise funds, and to potential investors:

The process isn't for the faint of heart or for entities that may not have a legal structure or much financial history. Although the costs aren't yet known, there will certainly be some legal or accounting expenses involved.

Related: How Established Businesses Can Benefit From Crowdfunding

There are also liabilities and restrictions to keep in mind:

While they wait for the rules to be finalized, more and more crowdfunding platforms are opening up to accredited investors. So although you can't yet invite your community to invest, there are two viable forms of equity crowdfunding in action:

Despite the requirements, equity crowdfunding is an exciting proposition for both entrepreneurs and investors as it has the potential to bring billions of dollars into the world of small business. The issue is that venture capitalists may balk at investing in companies that have hundreds of small and unsophisticated backers amassed from the "crowd round," so you may want to consider this consequence before deciding to post on an equity portal. Some platforms try to alleviate this concern by pooling the investors into one unit or LLC that holds the shares, so future investors will have to deal with only one entity. Be sure to research how the equity portal you choose handles this element.

Some pros of equity crowdfunding include:

Some cons include:

Related: New Crowdfunding Platform Gives Hardware Innovators Realistic Production Sources