On Oct 23, the Securities and Exchange Commission announced proposed rules to allow unaccredited investors to participate in equity crowdfunding (referred to as Title III). This means that entrepreneurs will soon have a much wider pool of investors to reach out to for their funding needs. It also means that the landscape of equity crowdfunding will change radically in the year to come.
Title II of the JOBS Act lifted the ban on funding advertising back in September. As a result, small businesses are using crowdfunding platforms to reach out to accredited investors more than ever before. They are forgoing the traditional methods of fundraising, and with Title III eventually allowing non-accredited investors in the market; one could argue that equity crowdfunding could eventually become the standard method for entrepreneurs to raise capital.
Census data estimates that around 50% of small business ventures will fail within four years. This high failure rate makes it difficult for banks to evaluate if a small business is able to repay a loan, so interest rates on small business loans are high enough to significantly raise the cost of fundraising. Consequently, small businesses look for other, cheaper fundraising options so banks don’t consider small business loans to be profitable as they account for only a tiny fraction of a bank’s assets.
Equity crowdfunding is already providing funding solutions to entrepreneurs who have historically been underserved by banks and other financial institutions. Only about half of the entrepreneurs that apply for loans are approved, and even if they are, they will still have to pay high interest rates on a regular basis, which is not easy for a pre-revenue company to do.
With equity crowdfunding, there is not an approval process and no interest; entrepreneurs can start a fundraising campaign to find private investors who can provide capital during those early stages of a company as long as they remain compliant with securities laws.
The benefits of equity crowdfunding apply to investors as well. While investing in startups is a risky endeavor, the return can be much higher than other potential investment opportunities should a startup become profitable. The investments made through equity crowdfunding also tend to be long-term because the investor has bought a stake in a company that is in its early stages.
The proposed rules for Title III will soon allow almost anyone interested in investing in startups the ability to do so. Crowdfunding portals, like EquityNet, will likely become the first place entrepreneurs go to seek funding because the pool of investors is expected to grow at an exponential rate. Regulations are still in the works, but once policymakers have determined how to regulate the crowdfunding market, it will change how business is conducted in a capitalistic society.
Here’s a timeline on when we think these changes will occur:
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