32 ms·

New Crowdinvesting Rules Mean Everyone Can Play VC

53 points by jc4p 14y ago

durkie 14y ago
How exactly is this bill different from just normal contract law? Is it not already super common for small businesses to solicit money from friends/family in exchange for a share of the new company?
- wtvanhest 14y ago
  There is a lot of regulation around raising money for businesses of any size. In general if the investors are accredited you can raise the money, if the investors are non-accredited you cannot. In order for an investor to be accredited, they must make over $200,000/year or have a liquid net worth of over $1m. http://www.sec.gov/answers/accred.htm http://www.sec.gov/answers/accred.htm This bill builds in an exception for non-accredited investors to invest in much riskier companies. Before this bill, the only way for non-accredited investors to invest would be if the company went public which is very expensive.
  - gm 14y ago
    So is it illegal to have your acquaintances and family invest in your startup? If not, then have all startups been breaking laws all along? If not, then what's the difference? The link you mention does not address that issue at all (it just defines what an accredited investor is)
    - excuse-me 14y ago
      Technically it often is. The SEC never really cared because historically friends+family funded businesses didn't end up on the market. Your typical neighborhood Italian restaurant doesn't IPO. If it did, and grandma who gave you her famous meatball recipe, turns up with her team of IP lawyers things will get interesting The difference here is that you are inviting 1000s of random people to invest. Then even assuming you are totally honest and above board - once you are marginally succesfull the same VCs will come and screw these investors in the same way that they screw foudners.
    - JumpCrisscross 14y ago
      No it is not, you just have to provide additional disclosure and follow your state's "blue sky" laws. These are just a headache to keep up with which is why it can make an exit or VC raise down the line a bit harder.
      - wtvanhest 14y ago
        Blue Sky laws typically require investors to be accredited unless there are exceptions. Some states may allow for non-accredited investors to invest in startups, but I don't know of any. One area that may or may not work would be if your family member loaned you the money personally. That isn't considered an investment since it is a personal loan. But, in a personal loan, they couldn't ask for equity since that would be an investment.
    - dandelany 14y ago
      My understanding is that SEC Rule 506[1] allows you to have up to 35 "sophisticated" but non-accredited investors. The catch is that you "cannot use general solicitation or advertising to market the securities" - which means friends and family who you approach directly are fine, but a public crowdfunding campaign is not. The new crowdfunding rules will allow companies to publicly solicit a much larger number of investors, as long as the company is raising <$1 million, and each investor is investing <$10k or 10% of their annual income, whichever is lesser. Disclaimers: This is an oversimplification, the law has been passed but the SEC rules have yet to be written and enacted, IANAL and really don't know what I'm talking about. [1] http://www.sec.gov/answers/rule506.htm http://www.sec.gov/answers/rule506.htm
- citadrianne 14y ago
  It's common, but there actually is no exemption for friends and family. Those offerings should technically be done under the 506 exemption which require investors to be accredited. It was also illegal, before the JOBS Act, to engage in "general solicitation," which is what raising money via a publicly-viewable crowdfunding page would amount to.
  - durkie 14y ago
    That's what I was wondering -- I've heard of the accredited investor barrier to entry, but it does seem like rule 506 would allow for investment from anyone.
    - citadrianne 14y ago
      The exemption is just for private placement as opposed to an IPO. You still have to be accredited.
      - durkie 14y ago
        Really? Sorry, not trying to be dense here, but from what I see in 506.b.2.ii: Nature of purchasers. Each purchaser who is not an accredited investor either alone or with his purchaser representative(s) has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description. Sounds like to me that they just require you or your representative to "know what you're doing" if you're not an accredited investor.
      - rexreed 14y ago
        But isn't a general solicitation on a public site considered to be a public offering? My understanding of what a "public offering" is, is that any general solicitation to the public, without qualification, for investment in a security in a company, where a security is any investment without a guaranteed return (as opposed to debt). I understand that JOBS act allows to solicit up to $1M from unqualified investors, but does it allow public offerings of up to $1M without registration?
- tptacek 14y ago
  As I understand it (ie: barely), the problem here isn't that the SEC is going to send agents in black suits and sunglasses to arrest your parents; rather, the problem is that when a real VC's counsel reviews your company's paperwork, they'll throw a fit if there are nonaccredited investors in the company. As I understand it (less than barely), the biggest real-world issue is that nonaccredited investors can cause extremely expensive legal headaches down the road for a company if those investors decide they've been wronged by the company.
steve8918 14y ago
If there are initial investors into a startup via crowdsourcing, are there any protections given to these investors against the tricks that veterans would play, like dilution, preferred shares, etc? It seems pretty easy to me for someone to set up a startup, get initial funding through crowdsourcing, and then as it needs another round of cash infusion, it lets a bigger VC come in and dilute the hell out of the initial investors. It's actually less of a risk for VCs because they can let retail suckers take on the higher risk during the initial round, and if the startup survives, then they can swoop in and invest in a more promising company, and dilute the initial investors into nothingness.
- citadrianne 14y ago
  Those kinds of protections will be decided by the SEC, although I don't know if they'd think of that. But now is the time to tell them because it's in a public commenting period: http://www.sec.gov/comments/jobs-title-iii/jobs-title-iii.shtml http://www.sec.gov/comments/jobs-title-iii/jobs-title-iii.sh...
- itg 14y ago
  VC's were pushing hard for this bill under the guise of "job growth" and every politician bought into it. There were numerous folks who said it allows for fraud and the bill was pushed without looking at the can of worms it opens. It benefits the VC's while reducing protections for investors. I wonder how long before we start hearing stories about retail investors getting screwed over by VC's in the media and makes people even more wary putting money into the crowd-sourcing fad.
  - damoncali 14y ago
    I don't think the VC's like the crowd sourcing parts. That does nothing but cause them headaches. They like the other bits that let them stretch the truth about IPOs. I don't expect crowd sourced deals to get crammed down by VC's - there is too much risk in those deals to deal with a bunch of non-professionals. I expect crowd sourcing to be a red flag that kills your chances of raising professional rounds.
littlegiantcap 14y ago
I think the author is overlooking one very important thing. Crowdfunding for startups or small business isn't only about the financial return. Yes some people are going to put $100 into a company claiming to be the next facebook thinking they'll be rich. However, many, many more people will invest in these companies to be a part of something or support their friends and families etc. All of the satisfaction isn't derived from the return. That being said, protecting investors and maximizing their likelihood of return is going to be largely about the platform. What kind of deals do they facilitate? How do they vet? etc. The next year is going to be very interesting, and I'm excited to see how this pans out, especially because I'm one of those guys working on a crowdfunding platform.
- _delirium 14y ago
  I agree on motivations, but if that really is someone's motivation, can't Kickstarter already handle that? You put in your $100 just to help out and support your friends/family, and in return you get some swag or recognition or future product, but not an equity stake.
  - cube13 14y ago
    Kickstarter only allows projects that have a tangible end. They don't allow projects that have non-concrete goals like "make a business" or "hire people".
  - littlegiantcap 14y ago
    The problem with that though is the equity stake is an important piece of the puzzle. It may seem a little paradoxical, but by giving out an equity stake you're reinforcing the non monetary social rewards as much as the monetary ones. Not to say of course that the money isn't important because it is, but my point was there is many kinds of "rewards" an investor receives. Money is just one part of the equation.
  - rprasad 14y ago
    Kickstarter is essentially a form of prepayment triage: if enough people want to pay for your product in advance, you get the money to make the product. Crowdfunding is simply cash for equity. The investor is not getting a product, so the Kickstarter model does not work.
cmcewen 14y ago
If you throw enough spaghetti against the wall, some of it will stick. That doesn't mean you get to eat the spaghetti, nor does it mean the spaghetti on the floor has no cost.
- gm 14y ago
  wtf am I reading? I did not get the analogy. If only some spaghetti sticks to the wall, it means you have a messy wall, less spaghetti left to eat, and spaghetti that isn't all cooked yet. Sorry, but I do not get what you're trying to say.
  - cmcewen 14y ago
    Sorry, should have been a bit more clear. Some of the spaghetti being thrown against the wall (companies taking crowdsourced money) will stick (be successful), but the people who threw it (people putting in crowdsourced money) won't necessarily benefit the most, and there could also be damage from the spaghetti on the floor (failed companies). I'll work on my analogies.
    - gm 14y ago
      Ah, makes sense. Thanks.
dxbydt 14y ago
The key phrase is "Play VC". Much like getting an etrade account lets you "Play Daytrader". To do some serious damage you need a little more firepower.
- damoncali 14y ago
  Do you remember the day trading centers back in the bubble? They managed to do some serious damage.
api 14y ago
I have radically mixed feelings. On one hand, I'm all for democratization. On the other hand, this is a little bit like democratizing a fish tank by dumping in a couple of sharks. The average person simply has no concept or mental framework to even imagine the sort of high-powered sociopath one encounters in the business world.
confluence 14y ago
Yay! This is a great idea, isn't it everybody? I mean, unsophisticated investors who barely have the time or inclination to understand how financial markets work (because the have jobs/families) are just about to get the right to invest in the "new new thing". Now, I'm all for free rights, but that is just insane! When people get a whiff of possible massive resturns - housing, stock, emerging markets, options, lottery tickets, IPO issues, etc. - they "invest" in them wishfully thinking that they have even the slightest idea as to what they are actually doing (some do - but most don't). These are exactly the wrong type people who should be running extreme risk capital (which is why we have VCs in the first place). These people will get slaughtered. If average people can barely handle relatively regulated and tested markets like stocks, houses and IPOs - how the hell are they going handle startups which have an insane signal to noise ratio in a rising market where "successful" funding can hide business model "failure". But hey! There's no bubble right? The IPO market is soft. But who needs an IPO market when you have massive liquid pools of dark private retail capital. The lambs are coming in for the slaughter and the wolves are salivating with glee! If I understand this correctly, this new law may just be akin to the repeal of Glass-Steagall in 1999 (http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act). Let the games begin!

53 points by jc4p 14y ago

How exactly is this bill different from just normal contract law? Is it not already super common for small businesses to solicit money from friends/family in exchange for a share of the new company?

wtvanhest 14y ago
There is a lot of regulation around raising money for businesses of any size. In general if the investors are accredited you can raise the money, if the investors are non-accredited you cannot. In order for an investor to be accredited, they must make over $200,000/year or have a liquid net worth of over $1m. http://www.sec.gov/answers/accred.htm http://www.sec.gov/answers/accred.htm This bill builds in an exception for non-accredited investors to invest in much riskier companies. Before this bill, the only way for non-accredited investors to invest would be if the company went public which is very expensive.
- gm 14y ago
  So is it illegal to have your acquaintances and family invest in your startup? If not, then have all startups been breaking laws all along? If not, then what's the difference? The link you mention does not address that issue at all (it just defines what an accredited investor is)
  - excuse-me 14y ago
    Technically it often is. The SEC never really cared because historically friends+family funded businesses didn't end up on the market. Your typical neighborhood Italian restaurant doesn't IPO. If it did, and grandma who gave you her famous meatball recipe, turns up with her team of IP lawyers things will get interesting The difference here is that you are inviting 1000s of random people to invest. Then even assuming you are totally honest and above board - once you are marginally succesfull the same VCs will come and screw these investors in the same way that they screw foudners.
  - JumpCrisscross 14y ago
    No it is not, you just have to provide additional disclosure and follow your state's "blue sky" laws. These are just a headache to keep up with which is why it can make an exit or VC raise down the line a bit harder.
    - wtvanhest 14y ago
      Blue Sky laws typically require investors to be accredited unless there are exceptions. Some states may allow for non-accredited investors to invest in startups, but I don't know of any. One area that may or may not work would be if your family member loaned you the money personally. That isn't considered an investment since it is a personal loan. But, in a personal loan, they couldn't ask for equity since that would be an investment.
  - dandelany 14y ago
    My understanding is that SEC Rule 506[1] allows you to have up to 35 "sophisticated" but non-accredited investors. The catch is that you "cannot use general solicitation or advertising to market the securities" - which means friends and family who you approach directly are fine, but a public crowdfunding campaign is not. The new crowdfunding rules will allow companies to publicly solicit a much larger number of investors, as long as the company is raising <$1 million, and each investor is investing <$10k or 10% of their annual income, whichever is lesser. Disclaimers: This is an oversimplification, the law has been passed but the SEC rules have yet to be written and enacted, IANAL and really don't know what I'm talking about. [1] http://www.sec.gov/answers/rule506.htm http://www.sec.gov/answers/rule506.htm
citadrianne 14y ago
It's common, but there actually is no exemption for friends and family. Those offerings should technically be done under the 506 exemption which require investors to be accredited. It was also illegal, before the JOBS Act, to engage in "general solicitation," which is what raising money via a publicly-viewable crowdfunding page would amount to.
- durkie 14y ago
  That's what I was wondering -- I've heard of the accredited investor barrier to entry, but it does seem like rule 506 would allow for investment from anyone.
  - citadrianne 14y ago
    The exemption is just for private placement as opposed to an IPO. You still have to be accredited.
    - durkie 14y ago
      Really? Sorry, not trying to be dense here, but from what I see in 506.b.2.ii: Nature of purchasers. Each purchaser who is not an accredited investor either alone or with his purchaser representative(s) has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description. Sounds like to me that they just require you or your representative to "know what you're doing" if you're not an accredited investor.
    - rexreed 14y ago
      But isn't a general solicitation on a public site considered to be a public offering? My understanding of what a "public offering" is, is that any general solicitation to the public, without qualification, for investment in a security in a company, where a security is any investment without a guaranteed return (as opposed to debt). I understand that JOBS act allows to solicit up to $1M from unqualified investors, but does it allow public offerings of up to $1M without registration?
tptacek 14y ago
As I understand it (ie: barely), the problem here isn't that the SEC is going to send agents in black suits and sunglasses to arrest your parents; rather, the problem is that when a real VC's counsel reviews your company's paperwork, they'll throw a fit if there are nonaccredited investors in the company. As I understand it (less than barely), the biggest real-world issue is that nonaccredited investors can cause extremely expensive legal headaches down the road for a company if those investors decide they've been wronged by the company.

steve8918 14y ago

If there are initial investors into a startup via crowdsourcing, are there any protections given to these investors against the tricks that veterans would play, like dilution, preferred shares, etc? It seems pretty easy to me for someone to set up a startup, get initial funding through crowdsourcing, and then as it needs another round of cash infusion, it lets a bigger VC come in and dilute the hell out of the initial investors. It's actually less of a risk for VCs because they can let retail suckers take on the higher risk during the initial round, and if the startup survives, then they can swoop in and invest in a more promising company, and dilute the initial investors into nothingness.

citadrianne 14y ago
Those kinds of protections will be decided by the SEC, although I don't know if they'd think of that. But now is the time to tell them because it's in a public commenting period: http://www.sec.gov/comments/jobs-title-iii/jobs-title-iii.shtml http://www.sec.gov/comments/jobs-title-iii/jobs-title-iii.sh...
itg 14y ago
VC's were pushing hard for this bill under the guise of "job growth" and every politician bought into it. There were numerous folks who said it allows for fraud and the bill was pushed without looking at the can of worms it opens. It benefits the VC's while reducing protections for investors. I wonder how long before we start hearing stories about retail investors getting screwed over by VC's in the media and makes people even more wary putting money into the crowd-sourcing fad.
- damoncali 14y ago
  I don't think the VC's like the crowd sourcing parts. That does nothing but cause them headaches. They like the other bits that let them stretch the truth about IPOs. I don't expect crowd sourced deals to get crammed down by VC's - there is too much risk in those deals to deal with a bunch of non-professionals. I expect crowd sourcing to be a red flag that kills your chances of raising professional rounds.

littlegiantcap 14y ago

I think the author is overlooking one very important thing. Crowdfunding for startups or small business isn't only about the financial return. Yes some people are going to put $100 into a company claiming to be the next facebook thinking they'll be rich. However, many, many more people will invest in these companies to be a part of something or support their friends and families etc. All of the satisfaction isn't derived from the return. That being said, protecting investors and maximizing their likelihood of return is going to be largely about the platform. What kind of deals do they facilitate? How do they vet? etc. The next year is going to be very interesting, and I'm excited to see how this pans out, especially because I'm one of those guys working on a crowdfunding platform.

_delirium 14y ago
I agree on motivations, but if that really is someone's motivation, can't Kickstarter already handle that? You put in your $100 just to help out and support your friends/family, and in return you get some swag or recognition or future product, but not an equity stake.
- cube13 14y ago
  Kickstarter only allows projects that have a tangible end. They don't allow projects that have non-concrete goals like "make a business" or "hire people".
- littlegiantcap 14y ago
  The problem with that though is the equity stake is an important piece of the puzzle. It may seem a little paradoxical, but by giving out an equity stake you're reinforcing the non monetary social rewards as much as the monetary ones. Not to say of course that the money isn't important because it is, but my point was there is many kinds of "rewards" an investor receives. Money is just one part of the equation.
- rprasad 14y ago
  Kickstarter is essentially a form of prepayment triage: if enough people want to pay for your product in advance, you get the money to make the product. Crowdfunding is simply cash for equity. The investor is not getting a product, so the Kickstarter model does not work.

cmcewen 14y ago

If you throw enough spaghetti against the wall, some of it will stick. That doesn't mean you get to eat the spaghetti, nor does it mean the spaghetti on the floor has no cost.

gm 14y ago
wtf am I reading? I did not get the analogy. If only some spaghetti sticks to the wall, it means you have a messy wall, less spaghetti left to eat, and spaghetti that isn't all cooked yet. Sorry, but I do not get what you're trying to say.
- cmcewen 14y ago
  Sorry, should have been a bit more clear. Some of the spaghetti being thrown against the wall (companies taking crowdsourced money) will stick (be successful), but the people who threw it (people putting in crowdsourced money) won't necessarily benefit the most, and there could also be damage from the spaghetti on the floor (failed companies). I'll work on my analogies.
  - gm 14y ago
    Ah, makes sense. Thanks.

dxbydt 14y ago

The key phrase is "Play VC". Much like getting an etrade account lets you "Play Daytrader". To do some serious damage you need a little more firepower.

damoncali 14y ago
Do you remember the day trading centers back in the bubble? They managed to do some serious damage.

api 14y ago

I have radically mixed feelings. On one hand, I'm all for democratization. On the other hand, this is a little bit like democratizing a fish tank by dumping in a couple of sharks. The average person simply has no concept or mental framework to even imagine the sort of high-powered sociopath one encounters in the business world.

confluence 14y ago

Yay! This is a great idea, isn't it everybody? I mean, unsophisticated investors who barely have the time or inclination to understand how financial markets work (because the have jobs/families) are just about to get the right to invest in the "new new thing". Now, I'm all for free rights, but that is just insane! When people get a whiff of possible massive resturns - housing, stock, emerging markets, options, lottery tickets, IPO issues, etc. - they "invest" in them wishfully thinking that they have even the slightest idea as to what they are actually doing (some do - but most don't). These are exactly the wrong type people who should be running extreme risk capital (which is why we have VCs in the first place). These people will get slaughtered. If average people can barely handle relatively regulated and tested markets like stocks, houses and IPOs - how the hell are they going handle startups which have an insane signal to noise ratio in a rising market where "successful" funding can hide business model "failure". But hey! There's no bubble right? The IPO market is soft. But who needs an IPO market when you have massive liquid pools of dark private retail capital. The lambs are coming in for the slaughter and the wolves are salivating with glee! If I understand this correctly, this new law may just be akin to the repeal of Glass-Steagall in 1999 (http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act). Let the games begin!