An inventor or small business creator may soon have a new way to fund their enterprise, thanks to crowdfunding rules proposed by the Securities and Exchange Commission, which might be more useful for selling products than selling stock in a small company.
The SEC announced its draft crowdfunding rules on Wednesday, which would move stock sales beyond the realm of large venture capital firms and accredited Wall Street investors to allow startups to sell shares of their company directly to regular people, known as unaccredited investors.
The Jumpstart Our Business Startups (JOBS) Act signed into law in April 2012 called for the creation of these rules to offer startups the chance to benefit from the emerging market for crowdfunding, said SEC Chair Mary Jo White. The proposed rules will be open for public comment for the next three months before they are finalized.
Existing crowdfunding websites including Kickstarter and Indiegogo allow artists or entrepreneurs to offer various gifts or the finished product they are developing in exchange for donations, but they cannot sell company stock.
"We want this market to thrive in a safe manner for investors," White said.
Buying part of a startup is risky business for an average person who has never invested stock before, since many small companies fail in their early days. Selling shares of a business to people online could also jeopardize the chance of a startup getting more funding later on from an investment firm, which might see little benefit in the partnership, says John Taylor, head of research for the National Venture Capital Association
"Entrepreneurs can't go into a venture capitalist asking for funding and say 'by the way I have 1,000 shareholders,'" Taylor says. "That request is going to be dead on arrival."
Crowdfunding could be more beneficial to companies that want to make a device, since they could pre-sell products and give the investor a copy of the new gadget, the way Kickstarter helps fund people who want to build something and offer art or gifts in return, Taylor says.
"If you are making a new product you can launch a product up from crowdfunding and get the money up front, so you know how many buyers you have before you make the device," Taylor says.
The legal commitments of equity crowdfunding could also be a heavy burden for entrepreneurs once they are responsible for keeping promises to online investors, Taylor says. Investors of startups need to educate themselves on the risks, he added.
"An entrepreneur looking to take money from stock sales really ought to get good counsel on the front end," Taylor says. "They should also think of the funding they will need in the future and plan ahead. If you are trying to create a product you will be in a different position than if you want to build a company with a national presence."