On March 4, 2020, the investment world changed forever. Not because of the novel coronavirus outbreak. Not because U.S. Treasury yields fell to record lows, nor because the 2020 U.S. Presidential primary election became a two horse race between Bernie Sanders and Joe Biden.
No, not because of any of those things that mainstream media is talking about. Rather, because of something that no one is talking about but which has far bigger implications for investors than any epidemic or presidential race: huge proposed changes to regulation crowdfunding.
Those changes, which include upping the funding cap and reducing fundraising costs, inevitably pave the path for the equity crowdfunding revolution to finally go mainstream, and for retail investors to finally become formidable venture capitalists.
Why is that such a big deal?
Because, while retail investors have been able to invest in startups for a few years now, the quality of startups in which they were investing was low, due to legislative shortcomings. These proposed changes fix those shortcomings. That means that higher quality startups will start tapping into crowdfunding, giving retail investors significantly better investment opportunities.
That’s a huge deal. It’s an investing revolution like no other which gives retail investors an opportunity to turn small investments into million dollar paydays.
And it’s all happening right now.
A Little Crowdfunding History
Let’s take a step back here.
In 2012, then-U.S. President Barrack Obama passed the Jumpstart Our Business Startups (JOBS) Act. Title III of the JOBS Act — dubbed “regulation crowdfunding” — allowed for average, retail investors to partake in equity crowdfunding for startups and other private businesses.
It was the start of an investing revolution.
Before regulation crowdfunding, only venture capitalists and accredited investors (which the government defines as individuals with $200,000-plus in income and/or a net worth above $1 million) could invest in next-generation startups like Uber (NYSE:UBER) and Facebook (NASDAQ:FB) before they went public. Retail investors had to wait to until those companies debuted on Wall Street before they could invest in them.
The JOBS Act changed that. It democratized the investing world so that retail investors — not just venture capitalists and their wealthy friends — could invest in startups.
Shortcomings Thwarted the Crowdfunding Market
Regulation crowdfunding was a great idea. But the first iteration has significant shortcomings. Those shortcomings have ultimately kept the top start-ups from tapping into crowdfunding markets.
Specifically, as I stated in a February piece on crowdfunding, the first iteration of regulation crowdfunding had three significant shortcomings. The funding cap was too low at $1.07 million over a 12 month period, the upfront costs were too high at over $20,000, and the investment visibility was too limited since startups had to incur costs without being able to test demand for their offerings.
Because of those shortcomings, the best startups weren’t tapping crowdfunding. They raised funds through venture capitalists. In that world, they could raise far more at far lower costs.
So, what retail investors were left with in the crowdfunding world weren’t the next Amazon or Apple. They were startups which, quite frankly, weren’t good enough to raise any money in the venture capital world.
New Changes Give New Hope
On March 4, the Securities and Exchange Commission proposed significant changes to regulation crowdfunding legislature which addresses the shortcomings that have kept quality startups at bay.
Those proposed changes include upping the funding cap from $1.07 million to $5 million, reducing regulatory and filing requirements in an attempt to keep costs down, and allowing pre-offering marketing so that startups can “test the waters” prior to incurring any listing costs.
Those changes are significant. Most quality startups don’t raise less than a million dollars in any round. But many do have seed or pre-seed rounds in the $1 million to $5 million range, so upping the cap makes crowdfunding a more viable option for quality startups. At the same time, fundraising through a venture capital firm isn’t cheap — there’s also paperwork involved there which can run up to $10,000 or more. These changes look to bring Regulation Crowdfunding costs down to a comparable level.
Even further, the whole “testing the waters” idea is great, because raising venture money isn’t easy. Startups will look everywhere to raise funds. If they can test the waters in crowdfunding without having to commit any capital, they will.
All in all, then, these proposed changes, if passed, will open the crowdfunding floodgates. No longer will crowdfunding be a last resort option for the worst startups. Instead, it will be a comparable fundraising option for all startups. Over the next few years, you will start to see higher quality startups tap into the crowdfunding markets.
That means more and better crowdfunding investment opportunities for retail investors, and that finding the next Amazon or Apple on a crowdfunding platform like SeedInvest will become increasingly likely.
Bottom Line on Regulation Crowdfunding
Regulation crowdfunding, as it stands today, has significant limitations which makes crowdfunding an unnecessarily risky pursuit for retail investors. You won’t find the next Apple or Amazon on crowdfunding platforms today. Instead, you’ll find all the companies that venture capital firms refuse to fund.
But, the SEC recognizes these shortcomings. So they are proposing some big changes. Those big changes, if passed, will completely change the crowdfunding landscape. Above all else, higher quality startups will tap into crowdfunding, and retail investors will be given more and better early-stage investment opportunities.
In other words, while the crowdfunding revolution began in 2016, it’s about to kick into a new gear.
My two cents is simple. Sign up on a crowdfunding platform like SeedInvest. Don’t rush to invest in any of the companies on there. Closely watch the crowdfunding market. See how things develop over the next few months. When the proposed changes get passed — I do think this is a matter of when, not if — closely analyze the new deal flow on crowdfunding platforms. As the deal flow picks up, and you start seeing higher quality startups on there, then invest.
After all, one of those companies could end up being the next Amazon or Apple.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.