October 30, 2015

The Securities and Exchange Commission (SEC) has sanctioned a new form of crowdfunding that will allow startups to legally offer investors a stake in their venture through the online sale of shares.

In a public meeting, the SEC adopted rules allowing for the implementation of a 2012 law that legally opens the possibility of securities crowdfunding by a vote of three to one.

For years, startups, entrepreneurs, and individuals have used the internet to raise capital to fund projects, however, starting in mid-2016, businesses will be able to sell a stake in their company through online platforms that are registered with the SEC.

New legal methods of raising funds is good news for businesses, but for investors there is an element of risk. Almost half of all startups fail within the first five years, and some are voicing warnings that online investment crowdfunding could be prone to fraud.

Knowing this to be the case, SEC chair, Mary Jo White, stated at the public meeting before the vote, that the SEC “will begin immediately to keep a watchful eye on how this market develops.” The agency will track what types of companies are using the offerings, how they adhere to regulations, and if the new crowdfunding system advances the raising of capital and protects investors.

Under the rules of use, individuals with an annual income or net worth less than $100,000 will be allowed to invest a maximum of 5% of their yearly income or net worth, or $2,000 whichever is greater. If a person’s income exceeds $100,000 they will be allowed to invest up to 10%, with no individual allowed to invest more than $100,000 during a 12 month period across all crowdfunding offerings. In addition, investors will not be allowed to resell their crowdfunding securities for 12 months.

Companies will have a fund raising cap of $1 million per year imposed without registering with the SEC. Companies will be required to supply information to investors regarding their business plan, how they will use the funds, and a list of their officers, directors and any individuals holding a minimum stake of 20% in the company.

The SEC had originally began considering this crowdfunding proposal two years ago, and a wide field of startups in fields including food, agtech, medicine, and biotechnology have been eagerly awaiting a decision.

The goal of the 2012 law was to assist startups that found it difficult to gain the attention of venture capitalists or other mainstream investors to raise funds. Supporters of the legalization of securities crowdfunding claim it will spark economic growth, create jobs, and launch more businesses. However, the state securities regulators’ association cautions investors to be “extremely cautious”, warning that companies raising funds could be inexperienced, or fraudulent, adding that investors would find it near impossible in such a case to resell their securities, and would have to pay for any lawsuits out of pocket.