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The Pros and Cons of the SEC’s New Crowdfunding Rules

Know the rules before you invest in the next big idea

By Dan Mayfield, Main Street Investor


The Securities and Exchange Commission’s new rules for equity investing in crowdfunding sites are chock full o’ good and bad news for you.

In short, this could be a very good thing for investors—just know what you’re doing.

Here’s what you need to know…

PRO: You can now invest in your favorite little startup much easier.

CON: You’ll be dealing with a company that’s not nearly as sophisticated, generally, as a firm that actually trades on a stock exchange.

The SEC’s new crowdfunding rules also mean you’re limited as to how much money the company can actually raise, and how much an individual can invest.

Regardless, it’s a move that many have been looking forward to, especially entrepreneurs and startups.

“There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendments provide smaller companies with innovative ways to raise capital and give investors the protections they need,” said SEC Chair Mary Jo White in a news release.

“With these rules,” said White, “the Commission has completed all of the major rulemaking mandated under the JOBS Act.”

But, the new rules allow pretty much anyone to launch a company, and take investors, right now.

CON: In SEC rules, to invest in a startup company, you have to be an accredited investor. Not many are.

Accredited investors are usually the one percenters; those with a net worth of more than $1 million, not including their home, or an income of more than $200,000 annually.

That’s a high hurdle to meet—and one of the reasons startups struggle to raise funds.

PRO: However, the new rules allow anyone to set up something like an Indiegogo or Kickstarter campaign and offer real equity in the company.

Crowdfunding is a clever idea, and most have used it to help fund new art projects, college educations, public projects and more. The idea is that by leveraging a crowd of people to fund a project, each pitching in a small amount, the project gets funded.

The problem for startups with crowdfunding is that investors got little more than a thank you note for their help in funding the project.

The new rules allow actually stock, equity, in a company, to be sold on these platforms.

Several U.S. states as well as the European Union have already allowed crowdfunding like this.

Sure, there are rules designed to stop fraud and to stop the unsophisticated investor from losing everything on a bad investment. The stock is to be sold through a brokerage or a specially licensed and registered site.

PRO: You could get in early on the next Twitter (TWTR) or the next Intel (INTC).

CON: You could get in early on the next WebTV (which, of course, went bankrupt.)

Still, there are limits, according to the SEC…

The new rules permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.

Unaccredited investors over a 12-month period, can invest in the aggregate across all crowdfunding offerings if either their annual income or net worth is less than $100,000, than the greater of $2,000 or 5 percent of the lesser of their annual income or net worth.

During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000

The rules are pretty explicit to prevent both fraud and one investor making a run on a startup and gobbling up all of its stock before it goes public.

Many have expressed concerns, though, that with such early stage investment, a startup could be overwhelmed with the legal and compliance issues surrounding a startup.

An early stage company without a huge regulatory staff could quickly have hundreds of investors, some of who could be very active (read: bossy).

Others have said that the rules open up unsophisticated investors to potential fraud, or worse, simply bad investments.

Bottom line: Before you jump into the world of crowd-funded investments, do what any prudent investor would do and look seriously at the company, its pitch, its health and the experience of its team.

This post originally appeared in mainstreetinvestor.com

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Article printed from InvestorPlace Media, https://investorplace.com/2015/11/pros-cons-secs-new-crowdfunding-rules/.

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