The SEC voted unanimously in October to advance rules that would permit startup businesses to cast a wider net in raising capital through online crowdfunding portals. The proposed rules set the stage for what could look like a tempting new investment opportunity.
Startups could raise up to $1 million in a 12-month period from unaccredited investors, although levels of contribution would be capped by their income or net worth. Under current law, the sale of securities to individuals is limited to accredited investors with a net worth of more than $1 million (excluding their home) or those who earn $200,000 or more per year.
While the proposal is far from finalized, some advisors worry that the new rules could inspire irrational enthusiasm among clients who envision getting in on the ground floor of the next Facebook or Twitter. Investors who like an idea but have no experience working with startups could easily overlook a weak financial statement, a dubious business model or something more nefarious, warns Patricia Powell, founder and CEO of the Powell Financial Group. "I have a lot of concerns," she says. "You can't even imagine how many opportunities there might be for fraud with this kind of scenario. Advisors are going to spend a lot of time trying to keep people away from this."
The crowdfunding rules stem from the 2012 JOBS Act, which aimed to make it easier for entrepreneurs to raise capital to launch small-scale startups. The rules are unlikely to go into effect before next fall, says Brad McGee, co-founder of iCrowd, an online forum billed as a social network for entrepreneurs and investors.
As they stand now, the rules would require startups to work through either a registered funding portal or a broker. Funding portals would have to register with the SEC and would likely be overseen by FINRA, although the proposal suggests that oversight would not be as stringent as the regulation of brokers.
McGee, who is co-owner of a broker-dealer that would work with iCrowd to facilitate startup investments if the rules take effect, argues that the SEC's proposal contains meaningful safeguards to protect investors from buying into poorly conceived or even fraudulent ventures. Startups seeking crowdfunding cash would have to provide disclosures about their leadership, business model and financesinformation that would be posted online and could enable investors and financial professionals, collectively, to vet the company.
Startups seeking to raise $500,000 or more would also have to produce an audited financial statement; those offering between $100,000 and $500,000 in securities would be required to offer financial statements that have been reviewed by an independent public accountant.
Some advisors remain skeptical that crowdfunding will actually see wide adoption. Timothy Speiss, partner in charge of EisnerAmper's Personal Wealth Advisors Group and vice president of the firm's wealth planning arm, is skeptical that inviting investors with modest incomes and assets to invest in startups will have the desired effect of a massive infusion of capital.
"I don't see billions of dollars of capital coming from non-accredited investors in this economic climate," Speiss says. "It's a great idea, but I don't think the construct is going to fill the objectives."