The opening of equity-based crowdfunding in the U.S. provides a new option for entrepreneurs to raise money from individuals who want to invest but don’t meet the definition of an accredited investor.
Federal regulations that took effect May 16 allow entrepreneurs to sell shares and raise up to $1 million from investors over 12 months through a crowdfunding platform.
Investors who earn less than $100,000 annually are now able to invest up to 5 percent of their income or $2,000, whichever is greater, in equity crowdfunding campaigns during a 12-month period. Individuals making more than $100,000 a year can invest up to 10 percent of their income each year.
Advocates of crowdfunding herald the day as a much-needed change that gives small businesses a new avenue to raise startup capital.
Equity crowdfunding adds to the sources of startup funding that are closest to entrepreneurs, said Kevin McCurren, executive director of the Richard M. and Helen DeVos Center for Entrepreneurship and Innovation at the Grand Valley State University Seidman College of Business.
“It’s money that replaces friends and family and credit cards,” McCurren said.
David Brophy, a finance professor and director of the Office for Study of Private Equity Finance at the University of Michigan Ross School of Business, views equity crowdfunding not necessarily as replacing friends and family but making it easier for them to invest in small businesses.
A prospective investor who wants to put money into a business started by a friend or family member would no longer have to go through the bureaucracy if the company engages in a crowdfunding campaign, he said.
“The most immediate impact will be on the friends and family level of investor. It used to be ‘I can’t do it because I’m not an accredited investor,’” Brophy said during an interview at the Michigan Growth Capital Symposium in Ypsilanti, an event he started 35 years ago. “It engages people to encourage friends and family to start businesses and enables them to help them along without the fears of the SEC and getting a lawyer and all that stuff.”
Prior to the implementation of what’s known as Title III of the 2012 Jumpstart Our Business Startups (JOBS) Act, a person needed to meet the definition of an accredited investor to put money into a company in exchange for an equity stake.
But who exactly will use crowdfunding to make an investment or solicit investors remains a question.
“It’ll be for ‘Main Street’ businesses,” McCurren said.
A small business raising startup capital through crowdfunding previously was limited to campaigns that offered an investor some sort of reward or was debt-based with a commitment to allocate a certain percentage of revenue toward paying off investors.
In 2014, Michigan opened equity-based crowdfunding with a state law that allowed in-state investors to put money into Michigan-based companies. Only a handful of companies have used the Michigan Invests Locally Exemption (MILE) Act for crowdfunding campaigns. Most of those have been based on the revenue-sharing or reward model.
Crowdfunding has started to carve out a niche among craft brewers and brewpubs that need capital. That industry and other lifestyle businesses are ideal for crowdfunding, which tends to attract investors who want to support a certain type of company that they themselves patronize, McCurren said.
“It tends to be the passions people enjoy,” he said.
However, crowdfunding is surely not the panacea for entrepreneurs seeking capital. It has a role but may not make a good fit for startups that will later need follow-up capital to grow, McCurren said.
“If you have capital needs, you’re not going to want a capital table with 100 or 200 people at it, and every time you need more capital you need their approval,” he said.