One of the biggest challenges that prospective entrepreneurs face is generating enough money to get their business off the ground. While bringing on investors has always been an option, another financial backing opportunity know as crowdfunding was technically against the law for small businesses. Crowdfunding is a subsidizing method whereby a large group of individuals combines financial resources with relatively small amounts of money, to help raise capital for a new business venture. In the past only wealthy investors with large assets could invest in small businesses. New legislation known as the CROWDFUND Act aims to make equity crowdfunding a legal and viable option for investors and small businesses in the United States.
How Equity Crowdfunding Works
Equity crowdfunding is a process that involves soliciting small investments from a very large number of people at the same time. An equity crowdfunding platform can be utilized online to reach potential investors from around the world. Although using an equity crowdfunding platform in the United States is not yet legal, it is legal and successful in other countries such as the U.K. and China.
Investors can go to the website, read information on the business proposal, and then have the opportunity to invest in the business. Typically, the investor can pay with a credit card or with a third-party payment processor like PayPal. The crowdfunding platform then tracks the money and eventually distributes it to the entrepreneur at a specific time. The investors can be compensated for their investment by receiving an ownership stake in the business, based on the amount that they invested. The payments to the investors can be handled through the crowdfunding platform or in some cases are made directly to the investors in the company.
In the past, only wealthy people were able to invest in small companies. There were limits on the number of small investments that could be made to companies. The problem with selling ownership to others online in a public manner is that currently, businesses have to file registration with the Securities and Exchange Commission (SEC), which usually costs millions of dollars to complete. With the passing of the CROWDFUND Act, small companies would be able to avoid having to file with the SEC and could instead sell stock directly to investors online.
The CROWDFUND Act prohibits companies from raising more than $1 million through this method. Companies also cannot receive more than $2,000 in investments from a single investor who makes less than $100,000 per year. Investors also have to understand that their shares of ownership will not be tradable for one year.
Currently, the SEC is working on the regulations that the President signed into law; crowdfunding is legal but not yet active, and the SEC has to establish the rules and documents to be used. The SEC is in the rule-making period.
This is a landmark piece of legislation that can completely change the way that businesses raise money. Currently, businesses can use similar methods to raise money for business ventures, but they cannot sell equity (ownership) in the company. They can only take donations from people who want to help start the business. By making it possible to sell equity (shares of stock), this will open the door for more investors to get involved and fund private businesses. This will facilitate many more businesses coming into the market, because they will finally have access to the capital they need to get started.