‘Crowdvesting’ is legal, but most capital rules still apply
Investing in startups has been the vocation or avocation exclusively of wealthy Americans since the Great Depression. Rules requiring a net worth of $1 million or an annual income of $200,000 for two consecutive years safeguarded the public from 100% of the risks that became all too real in October 1929. Unfortunately, for 85 years these rules have also denied most Americans 100% of the opportunity for rewards.
With passage of the JOBS Act of 2012, Congress loosened the reigns on rulemaking, which opened the possibility for an investing revolution similar to what has happened with online fundraising. Sites like Kickstarter and Indiegogo raised more than $5 billion last year for independent projects, charitable causes and other non-equity fundraising efforts, and now entrepreneurs can offer investors a stake in their companies as well.
To date, the U.S. Securities and Exchange Commission (SEC) has not finalized rules for equity crowdfunding or crowdvesting, but the state of Indiana has charged ahead with its own rules. Indiana entrepreneurs can raise up to $2 million and Indiana investors can invest up to $5,000 per opportunity.
Secretary of State Connie Lawson spoke briefly about these new rules before TechPoint’s sold out New Economy New Rules panel discussion Friday featuring Carol Mihalik (Securities Commissioner, State of Indiana), Kevin Hitchen (Founder, Localstake), Chris Baggott (Co-Founder, ExactTarget & Compendium), and moderator David Hooper (Partner, Barnes & Thornburg). The event is sponsored by Barnes & Thornburg and LightBound.
WATCH VIDEO: Crowdvesting is legal. Now what?
“I’m certainly pleased to see such a large group of people here and such a large interest in crowdfunding … its about helping good ideas get off the ground,” Sec. Lawson said. “So this new market will change the way Indiana entrepreneurs and investors connect. Hoosier companies are now able to raise up to $2 million over internet-based crowdfunding sites, and Hoosier investors are able to invest up to $5,000 in homegrown Indiana companies.
“So crowdfunding is now available in Indiana to startups and existing private businesses, and it can be used in conjunction with other more traditional financing options. By using multiple investors on a smaller level, crowdfunding may allow the entrepreneur to stay in control of the vision and the direction of the business, which I know is very important, especially for early-stage firms. It’s intended to be one more tool to help Indiana companies get off the ground and stay productive, and for investors these rules create a new world of possibilities and obviously there’s a new type of investor as well, because now anyone can invest up to $5000 in an Indiana-based offer.”
Secretary Lawson also urged the tech, startup and business communities to help get good deals running through the pipeline. Kansas has apparently had a capital framework similar to Indiana’s new equity crowdfunding rules since August of 2011, but so far that state hasn’t even surpassed 10 deals.
The most important thing to know about crowdvesting as it stands today is that it is not the Wild Wild West like Kickstarter, Indiegogo and others. No matter what you may have heard, you are still going to need an excellent attorney, whether you are an investor, a startup or an Internet web site operator.
Step 1 – Register with Internet web site operator (currently only Localstake)
Step 2 – Read prospectus and do your own due diligence on offer
Step 3 – Follow Internet web site operator process for investing in offer
Step 1 – Register a crowdfunding offer (follow Form D instructions under Title 710)
Step 3 – Connect with Internet web site operator (currently only Localstake)
Step 4 – Provide full and fair disclosure on offer (prospectus)
All of the forms and available information about equity crowdfunding is posted on the Indiana Secretary of State’s website Securities Division.
HIGHLIGHTS FROM THE PANEL DISCUSSION
David Hooper, Partner, Barnes & Thornburg
“Crowdvesting has been a hope and a vision more or less for many entrepreneurs for many years, but now we’re finally beginning to see how these visions and hopes are actually being manifested into actual legislation and actual rule making that can actually be used for the first time to raise capital …
“We’re really lucky to have a Secretary of State’s office and a Securities Division that has been at the forefront of developing these rules and balancing both the capital raising interests of our entrepreneurs with the legitimate interest in preventing fraudulent offerings of security … Indiana is one of only 12 states that have actually passed and approved crowdfunding exemptions — there are other states that are considering crowdfunding exemptions and going through the legislative and rulemaking process, but Indiana is one of only 12 — and many states just came to the table on this topic within the last month, so we’re really at the forefront here.
“Number one, the issuer of the securities must be organized within Indiana to take advantage of this exemption. Number two, there is an intrastate scope to this-this is not an exemption where the issuer in Indiana can go outside of Indiana to raise the capital, you can’t go outside of Indiana to use the proceeds of the offering, this is an intrastate scope of the exemption. Number three, there are per offering and per investor caps — $2 million on the high end, and the per investor cap is $5,000 per offering, and number four, the crowdfunding offering must go through an Internet platform.”
Carol Mihalik, Securities Commissioner, State of Indiana
“We now have a new exemption, and this new exemption allows for access only in Indiana among Indiana residents and Indiana businesses, that these startups can for the first time access everyday people in Indiana. When I’m sitting at home on my laptop, I can go on the Internet and find an investment, even though perhaps I am not what would be considered an accredited investor … I can now choose to invest in a local private offering unlike never before up to $5,000 from home looking on the Internet.
“This is the first time a startup company can reach an Indiana investor at home on the Internet. It’s wonderful for the startup company and potentially wonderful for that investor, too. Because I can choose as that investor to invest locally in something that appeals to me, or we’ll hear from others, perhaps I’m related to someone and I couldn’t even invest before, but what a great opportunity and what a great opportunity for the company to raise some new capital from some new people that they’ve never had access to before.
“I think the estimates are accredited investors are only 7 percent of the population, so look at all those people that startup companies can suddenly reach that they didn’t have that opportunity to reach before.”
Kevin Hitchen, Founder, Localstake
“I think we’ve all seen the power of the rewards-based, donation-based crowdfunding. It’s pretty successful. So the Kickstarters, the Indiegogo websites out there, what started in kind of the late 2000s, in a matter of five or six years, I think it was last year, crowdfunding hit about $5 billion in funding raised, and that’s a crazy large dollar amount, and you have people thinking, can that whole mentality, that process be transferred over to how businesses raise funding, right? So historically, when businesses have raised capital, it was a pretty inefficient process, where you could only go to people who were, for the most part, high net worth individuals. It involved having to know a lot of wealthy individuals and a lot of them primarily invested only in certain industries like technology or life sciences or it even involved very inefficient processes where it was a lot of coffees. If you’ve raised money before you know how long it takes to raise funding, how many coffees you’re going on and things like that, and it took six month or a year to raise funding. With the Internet kind of evolving, it’s changing just like how it’s changing a lot of different industries, it’s making it more accessible.
“It’s not exactly the same, but in some ways it starts to look like etrades and Scottrades out there, but instead of investing in mutual funds and publicly traded companies, you’re investing in private companies. Like I said, it’s not exactly the same, but that’s a way to kind of start to think about it as a mentality. I think that’s why it’s very interesting to people because you have people pushing back on ‘maybe I’m not completely satisfied with the stock market’ or ‘maybe I want to help out my local economy and help out this company I believe in to expand.’ So there’s a lot of reasons why people are going to invest, maybe beyond just the potential for financial return, which is different than kickstarter and Indiegogo. With crowdvesting you can get more than just a T-shirt or a club membership, you get an investment in a company. So I think that’s also attractive to people.”
Chris Baggott, Co-Founder, ExactTarget & Compendium
“It’s phenomenal (crowdvesting), and I’ve been an advocate of this for a long time. We sort of stumbled over this model — I should say, left out my bio is my latest startup is called Potluck Capital, and we’re an (crowdvesting) operator as well — but we started ExactTarget in 2000. We we’re right in the ‘dotcom’ bust, there was no money to be had and we were hugely unqualified to start a business like this, none of us had any software experience. But we knew a lot of people, so as we couldn’t raise big chunks of money, we kind of stumbled on this model of raising small chunks of money.
“Little known about ExactTarget is that we went door to door, like in my neighborhood … there are 9 houses in my cul de sac and there are five swimming pools, all those swimming pools are people who invested $5,000 in ExactTarget. But they had to be accredited, so we went through our rolodexes and all of our college buddies and everybody we ever met trying to collect these $5,000 checks, and we ran into this wall of accreditation, that if you — at the time — didn’t have a $200,000 salary or a million net worth you couldn’t invest in ExactTarget. I’ve been an advocate of this because it worked. One of the reasons we had to go public is because we had over 500 private investors in ExactTarget and they were highly risky and really dumb investments on the part of the people who made them (Editor’s note: This received a HUGE laugh from the audience. ExactTarget sold for $2.5 billion last year.) but it worked out. So I’ve been just a strong advocate of this, you know, especially in the early stage.
I do a lot of angel investing and I find myself writing a lot of the $5000 or $10,000 checks and it’s the raw seed money to say, ‘does this idea deserve to live for three or four months to see if it can get going?’ That’s how I look at this (crowdvesting). I don’t really think we’re going to see a lot of million dollar crowdfunding deals. I think we’re going to see a lot of $50,000, $100,000 deals that say ‘I need to hire a developer and a small team and let’s get some runway to we can get from point A to maybe point C and build some credibility to then go out and get some real money from accredited investors,’ and that’s how I see this working.
“And the fact is, those of you interested in getting investment at this level you already know the people who are going to invest, they are your aunts and uncles and your dad and your mom and your sister and the guy you went to college with and your army buddy or whatever. Being able to tap into that audience — people who have faith in you — with a low enough number that nobody can get hurt. That was the thing we always loved about $5,000 as well was no one was going to like lose their house if you blow their $5,000 versus if someone gives you $50,000 suddenly that becomes meaningful.