Professor at Case Western Reserve University
Now that anyone can now buy shares in a private company through an equity-crowdfunding platform, interested investors are wondering who will operate the online share-buying sites. Some observers have suggested that rewards-based crowdfunding platforms like Kickstarter and Indiegogo will enter the market, taking advantage of their experience in other parts of the crowdfunding marketplace.
However, I think reward-based crowdfunders are unlikely to enter the business, leaving the market to companies that have been set up explicitly to engage in the sale of shares to the crowd. Here’s why:
The types of investors who put money into reward-based crowdfunders aren’t the ones who will buy shares through equity crowdfunding – at least not at first. The Securities and Exchange Commission still has not written the rules for the version of equity crowdfunding that will operate under Title III of the Jumpstart Our Startups (JOBS) Act, and that’s the kind that would most appeal to people who have funded businesses and projects through rewards-based crowdfunding.
The new equity-crowdfunding platforms will be operating under Regulation A+, which allows non-accredited investors – people with less than $1 million in net worth or $200,000 per year in income – to make equity-crowdfunding investments. But Regulation A+ is too costly and time-consuming to be worthwhile for efforts to raise small amounts of money, crowdfunding experts David Freedman and Matthew Nutting explain in a recent article. Therefore, until the Title III rules are written, rewards-based crowdfunders won’t have the advantage of an established customer base to attract buyers to equity crowdfunding.
Moreover, rewards-based crowdfunders lack the key expertise for managing an equity-crowdfunding platform. While Kickstarter and Indiegogo know a lot about running a two-sided platform that matches buyers and sellers, that expertise is neither rare nor valuable in the equity-crowdfunding business. Regulation A+ platforms need to be affiliated or registered with a broker-dealer of securities, register with FINRA and maintain certain levels of capital – a type of expertise that rewards-based crowdfunding platforms have never had to develop. As a result, rewards-based crowdfunders lack a key competency that would provide them with an advantage over new entrants in this space.
Lawyers for Kickstarter and Indiegogo will advise them not to enter the market until the SEC makes clear the rules for site liability and deal curation. As the two Chicago-based crowdfunding experts explain in their book, the SEC has not yet said whether non-broker-dealer portals may use subjective criteria to select investment opportunities for their platforms, and Title III of the JOBS Act implies that they cannot. If the SEC rules that using subjective criteria would be akin to offering investment advice (which only broker-dealers can do), then crowdfunding platforms will have to post all investment opportunities that meet objective criteria. That approach will eliminate any advantage that rewards-based crowdfunders have in knowing how to select businesses to feature on their sites.
If the SEC rules that crowdfunding sites would be liable for any misrepresentations and omissions made by issuers, lawyers for the reward-based crowdfunding sites will stop them from entering the market. That’s a fairly likely scenario, given that Title III of the JOBS Act implies that online platforms might be liable for fraud, inaccuracies and omissions that issuers on their platforms make.
Finally, equity crowdfunding is likely to attract the attention of financial institutions, which have expertise at being broker-dealers. These entities will either start from scratch operations in equity crowdfunding or, more likely, track the startups in the industry and acquire the most successful ones. Given the advantages that financial institutions have in the securities business, these companies will be formidable competitors to rewards-based crowdfunding platforms in equity-based crowdfunding.