SEC Allows Crowdfunding

Kickstarter is not an investment, and no matter how many times this is repeated, you’ll find the phrase ‘my investment’ in the comments section of nearly every failed Kickstarter, Indiegogo, or other crowdfunding campaign. These campaigns are more closely related to group buys, and you’ll never find a Kickstarter offering equity or any sort of return beyond the latest electronic bauble, indie game, or graphic novel. Sure, you may bootstrap a business with that pledge, but don’t expect dividends from Ouya or Pebble.

Now, this may finally change. The US Securities and Exchange Commission approved new rules for crowdfunding, allowing startups to raise money from Jane and Joe Internet.

Previously, angel investments, venture capital, and hedge funds were not for the common man; these were high-risk investments, and only accredited investors could participate in these funding rounds. Accredited investors, at least in the US, are individuals with a net worth of at least $1 Million, or an income greater than $200,000 in each of the previous two years. The reason for only allowing accredited investors – depending on your interpretation – is to protect consumers or to maintain a perverse oligarchy by installing a glass ceiling over the middle class. Either way, normal people couldn’t invest in high-risk investments until now.

Congress has seen fit to create a new class of investor, and pursuant to Title III of the JOBS Act, the SEC recently released the complete rules for crowdfunded investment. In a massive, 600-page tome, all the regulations are laid bare, ready for the next serial entrepreneur who seeks at most $1 Million in investment for their next startup.

Investors and Startups

The rules issued by the SEC immediately place some limitations on what can be done under the new regulations. For startups, a maximum of $1 Million can be raised over a 12-month period.

For investors with an annual income or a net worth of less than $100,000, a maximum of $2,000 or 5% of annual income can be invested, whichever is greater. For investors with an annual income or net worth greater than $100,000, 10% of their income or net worth can be invested, whichever is smaller.

Brokers and Funding Portals

Investors and entrepreneurs are not allowed to keep their transactions to themselves; this is the SEC after all. Transactions will go through registered broker-dealers or something called a ‘funding portal’. These funding portals are forbidden from offering advice, making recommendations, advertising, paying employees a commission, holding securities themselves, and the regulation bars directors, officers, and partners of the funding portal from holding investments using that funding portal’s services.

It’s The Complete Opposite of Kickstarter

Kickstarter was never known for its transparency. While the basic premise of crowdfunding the manufacturing of a few baubles or 3D printers is sound – it’s cheaper per unit to build a hundred of something than to build just one – the reality of actually building something meant Kickstarters failed – it’s exponentially harder to build ten thousand of something than it is to build a hundred. Add to this Kickstarter’s investments in campaigns featured on their website, and you have the recipe for practices that aren’t illegal but certainly don’t pass the sniff test.

The regulations put forth by the SEC turn the most common trope of the Internet economy on their head; companies responsible for bringing startups and investors together are not financially dependant on these startups. Companies can not raise more money than they could handle, and hopefully individual investors won’t take to crowdfunded companies like online poker and day trading.

Traditional crowdfunding has started a lot of great companies so far; the Form1 printer began as a crowdfunding campaign, and Reading Rainbow still lives thanks to a successful Kickstarter. With these new regulations come new possibilities for the latest startups, and more paths to success than a traditional angel investor or VC tycoon.

40 thoughts on “SEC Allows Crowdfunding

  1. US actually has a rule preventing people from making certain investments, aren’t your* money your money, surely I’m misunderstanding something ?

    * I’m obviously not from US, I’m from one of them socialist countries, so this is incomprehensible to me. When I’ve paid my tax, the money is mine to do whatever I want with.

    1. All regulations start because someone was abusing what was possible. Basically, what happened was businesses sought out large investments from individuals with the promise of getting rich. What happened was these people bet their life on high risk investments and lost everything. While you could say this is someones choice, it also has a negative effect on the economy. An accredited investor would be less likely to put money on something that has no chance, or is an outright scam, and if they did have a bad investment it wouldn’t ruin them.

      I imaging all the new regulations still take great care to protect the investor from danger, and ensure the transparency to prevent scams.

      Capitalism works great when done properly, all these regulations are here to compensate for the shortcomings of human nature.

      1. Hi Kratz, tried to reply to your other post but no option.

        Lotteries these days are entirely online ( that is the systems that run the transactions ). There are a few states that have adopted online betting systems where you load money into an account via bank transfer or debit card and purchase lotto,pick 3 etc. There are also a few that have e-scratch offs. The only real reason for the slow deployment of this across the U.S. is the individual contracts that state lotteries form with private companies like SGI and Intralot. These can be 10-20 years, so it takes some time to add in new features etc. I can tell you from experience as well that upgrading a standard transaction system to taking electronic wagers can take as long as a year due to fickleness of lotteries and long software reviews.

    2. In the US you can do anything you want with your money (wanna buy the Brooklyn Bridge?), but no-one can claim to be offering you an “investment” unless they meet certain criteria and follow the regulations. Fools abound in both socialist and capitalist countries…

        1. Sports betting online is still mostly banned but much of the 1961 wire act was overturned as recently as 10 years ago. It would be virtually impossible with how Powerball and megamillions are run these days to do it over anything but the internet.

          1. Lotteries are not online (at least not in Wisconsin), in the sense that you have to buy the ticket in person with cash or debit (no credit cards). The machine at the store is connected via the internet, which is probably why that ’61 law was overturned.
            Gambling online is legal (i think), but I think the sites must get state permits. I think there was a recent news story about Fantasy Football competition sites were ruled by Nevada to be gambling, so they would have to buy a permit in Nevada to operate there.

        2. It’s not letting me reply to your new comment. That said, yes slot machines etc can be connected over state lines and internet connections now. There’s actually been a huge growth in the giant parimutuels these last couple years because of this.

          1. That seems sensible, When laws designed 50 years ago that apply to technology that didn’t exist at the time are applied it seems crazy from an outsider’s respective. I always thought it was intentionally banned and thought that was a bit draconian. Glad too see things getting better, I don’t really gamble myself but I like the thought of I could if I wanted too.

    3. I think, at least with respect to US law, part of the confusion relies on the concept of the differences in how and what you can invest in, depending on your ability to qualify as an Accredited Investor.

      In order for an individual to qualify as an accredited investor, he or she must accomplish at least one of the following:

      1) earn an individual income of more than $200,000 per year, or a joint income of $300,000, in each of the last two years and expect to reasonably maintain the same level of income.

      2) have a net worth (excluding your primary residence) exceeding $1 million, either individually or jointly with his or her spouse.

      3) be a general partner, executive officer, director or a related combination thereof for the issuer of a security being offered.

      These investors are considered to be fully accredited, without all the restrictions that the SEC imposes that prevent investors who do not qualify as accredited from investing in those securities. Somewhat strangely, if you have assets but did not qualify as an accredited investor and want to invest in the general stock market, nothing prevented you from doing so.

      Also, an employee benefit plan or a trust can be qualified as accredit investors is total assets are in excess of $5 million.

      This change represents a markedly different direction that opens up previously unapproachable “smaller” investors, who were prohibited by law from investing in these securities, even if they wanted to and had the money to do so because they failed to qualify as an accredited investor. You couldn’t even legally solicit them. Which explains, in part, the success of crowdfunding efforts to date because there was no investing option available under US law so that wasn’t even possible.

  2. Yikes… I am glad to see some of these apparent changes, but also the limits on investment based on yearly income is simply draconian at best, and probably evil is a better word for it.

    Arbitrary and ridiculous to place a 2% limit on someone who makes 60-99k a year, has 400k saved and wants to invest big in something… What the actual Efff..

    At the same time, calling kickstarter pre-sales purchases ‘an investment’ strains credulity and makes the participants look like saps if they take that terminology at face value.

    So let me get this straight, to place investments on a future equity-based KS, you would have to prove your income to the site?

      1. Right, I understand that – but maybe the legal system should do it’s job.

        They don’t check your yearly income at the casino, for instance.. It is arbitrary and intrusive compared to other of the many ways to squander your money.

        There are already plenty of scam artists who operate with impunity for decades at a time. They get away with it because the legal system is a bit broken when it comes to these things.

        The rules proposed only seem to have one goal: forcing disclosure of income in order to take part in emerging online paradigms that are yet to have their full impact on ‘business as usual’.

        For instance casinos, etc are known to be havens of money laundering, and surely crowdfunding is also used for money laundering – however they don’t limit it for casinos by forcing each person to declare their income (and therefor also tacitly force them to disclose all income sources to every investment)

        In short, shady people already scam people out of all their money and the justice system basically fails to serve it’s purpose in many of these cases. Forcing people to disclose their income in order to place arbitrary limits on their investment activities seems quite over the top to me!

        1. I think you’re not understanding something here. You would have to file this on your taxes – not report it directly to Kickstarter. The same way you would report Casino losses ( if you actually do this ).

        2. Exactly. The Government plays this like it is trying to protect you. Actually it is a scam to protect the wealthy elites by reserving a lucrative market exclusively for them. Another scam is how IPO’s are accesible only to the wealthy elites when the newly offers shares are of most value. Then once the Elites secure their profits, what crumbs are left over eventually go to public trading. There are plenty other examples…

        3. The legal system can only act against these scammers after they’ve already bilked investors of everything they have. The SEC can’t take action before then because it doesn’t have the resources or the right to investigate every single small company that might turn out to be a scam. The maximum funding limit solves this by making it illegal for these investment schemes to take everything that someone has, meaning that the SEC can take action against anyone that tries this immediately without having to wait for evidence that they’ve blown all the money on drugs and parties.

          1. Scamming is already illegal – this law does nothing new to deter scam artists.

            Scam artists want 40K from grandma, this law wont stop the check from clearing.

            Google “QEG Scam”, “OPPT Scam”, etc. just to see some decades-long scams in which the scam artists dont get in any trouble.

            IMO the government and financial bigshots think it is funny that small people get scammed.

      2. I think your right I mean look at all the suckers that thought “solar roadways” was the best idea ever. People are easily duped online when it comes to something they only half understand. That laser hair removal thing as well too someone who doesn’tunderstand it seems like a safe bet.

    1. You have to remember, the regulators view this stuff in terms of the whole system. An aggregation, not the individual. It’s not about 1 person losing a significant percentage of their annual income in a bad investment, it’s the potential for millions to do the same in an economic downturn.

      Same reason for all the new mortgage regulations that popped up after the recession a few years back. It wasn’t one bank making a risky loan to one person, it was a few billion dollar bubble that popped and had serious consequences.

  3. People are still free to spend as much as they want in wall street though.. What a farce. This is the type of ‘regulation’ that empowers anti-social right wingers to condemn ideas like environmental regulation and other business regulation.

  4. To those objecting to the proposed caps for “crowdfunded” investing – is your objection that the nasty big ole government is oppressing you again, or is it because the regs will make it harder for you to fleece the clueless?

    There’s more to investing than being online, a bit drunk, and having a bank balance…

    1. If the focus of the regulation was strigent punishment of scam artists, you would be correct, and I would be quite happy to see this.

      Special financial tracking and reporting of expenses for crowdfunded startups would be a idea I would fully support – making misappropriation of funds tort a slam dunk for defrauded investors in the case the founders are scam artists.

      1. Theoretical scenario: There is a house in my neighborhood whose owner is willing to sell for 20 thousand dollars because he is under duress and needs the money like IMMEDIATELY. This house if you let it sit on the market for a few months could almost certainly be sold for a lot more money.

        If I ask a few people if they want to split the cost of the house to buy it now and immediately relist with a price tag of 40K, and we are going to divide the money gained from the sale…… Then the SEC now calls this a security.
        It is illegal for you to get people involved unless they are millionaires. It’s illegal to advertise in order to find investors unless you follow certain specific rules. and most importantly to me, NOONE that I personally know is legally allowed to have anything to do with something like this.

        There have been large swindles in “investments” in the past in this country. But these rules that define a qualified investor as a millionaire with 200K$ per year income were drafted in the 1930’s…… in 1938, the minimum wage was 25 cents an hour…..
        So the qualifications are still nominally the same even though our money is worth dozens of times less than it was at the time.

        These rules are completely outdated and completely inappropriate, no matter how you cut it.
        It often puzzled me why noone was using crowdfunding campaigns to buy real estate. All the relevant platforms (kickstarter, indiegogo, gofundme, etc etc) disallow real estate purchases.

        I have seen a couple of campaigns attempt to purchase land in order to create community greenspaces etc, and they were quickly locked and disabled.

        THESE regulations are the reason why.

        1. around here getting together to buy a house as an investment and not living in it means you get hit with full income tax on the gains, if you live in a house and sell it the gains are tax free.

          I’d also expect that things that qualify as an investment, any losses will count agains gains on other investments

      2. There’s grey areas though, like the many cases where someone offering a Kickstarter project genuinely intends to produce his widgets, but really over / under-estimated the costs involved, or some other factor. You could argue Kickstarter attracts people like that, since someone more established in business would just get a bank loan, or investments from business contacts.

        There’s been lots of cases where companies have sunk, simply because of over-optimism or ignorance. They’re not scam artists, they don’t deserve punishing as long as they were diligent and honest. But from the point of view of a disappointed “investor” the results are the same.

        Still, at least nobody expects a financial reward from their Kickstarter “investments”. Worst thing happens, you don’t get your new toy. Your family still has food and shelter. You can only lose out on things you didn’t really need. Kickstarter is really intended for getting bright ideas made into reality, for first-timers and inventors who aren’t in the business of whatever they want to do.

        Because of this, the fact it’s not a real monetary investment, the regulations are probably a good thing. If you want to make actual, real investments, you still can, that’s just covered under the existing rules.

  5. I spent awhile crafting a thoughtful and considered response to this article…. An article and thread that I find very interesting btw.

    And then I hit post and hackaday ate it.
    Just so you know :D

  6. Sorry Brian, the pedant in me couldn’t resist:

    “.. it’s exponentially harder to build ten thousand of something than it is to build a hundred ..”

    Yes, that exponent being two* … ? I’ll get my coat ????

    I do like your articles, but a couple of glasses of red wouldn’t let me leave this alone.



    * for the exponential pedants; (10^) two, obviously …

      1. Only if you allow a floating base (not 10) though?

        TBH I only included that bit to:

        A) show it was a light hearted comment
        B) hedge my bets against real pedant mathematician types
        C) it’s now 3 glasses of red, so please be gentle

    1. Agreed wholeheartedly I like Brian, however, that statement that keeps getting thrown around is bullshit. Economy of scale dictates often times it is much easier to produce 10,000 of something then 100. Especially if you use pre-existing manufacturing facilities.

      DIY manufacturing does follow the exponential difficulty.

      1. Thank you for articulating what I was trying to get at far better than I managed!
        If you’re going to write fore the STEMocracy? STEMopolites? STEMatae? then you have to get your superlatives right ????

      2. sorta, if you make 100 electronics gadgets it’s not a huge issue if few % needs manual rework because a footprint
        isn’t optimal or that testing is done mostly manually. If you need to build 10000 that isn’t possible

  7. I really never understood why the SEC would be involved in the first place. Yes you will see the word investment used on the crowd funding sites, but I have not seen it used in the context that the SEC would have jurisdiction. I have never seen any offers on the order of; for x. amount of dollars one is purchasing shares in the company with the expectation that the shares would produce income for the owners of those shares. I have to feel that crowdfunding can fill a need like no other method that I’m aware of can, and if crowdfunding is to die I’d rather see it down of it’s own hand. Allow the civil and criminal courts deal with the fraud and other problems. Yes that’s vetting after the fact, but I can’t demand the crowdfunding managers to know everything there is to know about everything to be able to fairly vet on the front end. The only regulatory item I’d place on the crowd funding managers is that keep an arbitrarily determined amount of donations be placed in escrow for an arbitrarily required length of time. Where that will tie up their income, as the courts go through their usual slow prorocess, they would have an incentive to vet as much as they can at the front end. As for the sucker born every minute; shrug, to be callous about it. In that group one would find those who knowingly support things that are wishful things for them and the understand that, who why deny them the right to spend their money as they see fit. For anyone truly worried about about the ignorant “investor” why not help educate? Because I was raised not to be a spendthrift there are few crowd funded projects that I’d consider supporting, because of that I don’t join in the hand wringing over the issue.

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