Crowdfunding Rule To Open Investing To Public

San Francisco Chronicle

Nick Tommarello wanted to invest in ideas that inspired him.

When his friend started building an exoskeleton to help disabled people stand and walk again, Tommarello wanted to invest. It wasn’t just that he liked his friend’s idea and wanted to help. He wanted equity, a tangible stake in the company that he could sell and trade for profit.

But he couldn’t. He wasn’t worth enough, financially.

“Right now, the rich have a government-protected monopoly on investing,” Tommarello said.

That changes Monday, when a provision of the 2012 Jumpstart Our Business Startups Act takes effect. The crowdfunding regulation will allow businesses to offer equity to people regardless of their net worth.

Prior to the Jobs Act, investing in private companies that might end up being worth billions of dollars — the Facebooks and Ubers of tomorrow — was a privilege limited, for all practical purposes, to private institutions and wealthy individuals known as accredited investors. To be accredited, you need to have an individual income of at least $200,000, a joint income of $300,000 or a net worth of more than $1 million.

Starting next week, anyone can invest in businesses they care about by logging on to a website, known as a funding portal, that meets the law’s requirements. The portals are designed to make sure that investors understand the risks in putting money into private companies.

Tommarello’s company, Wefunder, is among a handful of services approved by the Financial Industry Regulatory Authority as funding portals that will begin offering services Monday. The Securities and Exchange Commission regulates Wefunder and its competitors.

‘New standard’
“We’ve been waiting for four years for this moment,” said Tommarello, whose frustration at being closed out of investments inspired him to create Wefunder. “We’re going to make sure that we very quickly become the new standard for how it’s done.”

Tommarello started developing a prototype for Wefunder even before the Jobs Act became law. The legislation opened up the possibility that ordinary people could buy shares in startup businesses.

Excited by this possibility, Tommarello joined a grassroots lobbying effort in Washington. He started a petition on which would-be investors signed their names and wrote how much money they would invest if they were allowed. The pledges amounted to more than $4 million.

“It was surreal that a couple of tech people were now lobbyists,” Tommarello said.

Indiegogo’s co-founders were also among those calling for change. Indiegogo is a leader in the traditional crowdfunding business, where people contribute money for early access to products or perks related to an endeavor they want to support. But the only stake such crowdfunding supporters got was emotional, not financial.

Campaigns on Indiegogo have raised more than $850 million — but project backers have not received any ownership stakes.

Securities law prohibited the company from expanding into equity crowdfunding, as its co-founders, Slava Rubin, Danae Ringelmann and Eric Schell, had hoped to do when they started the company in 2008.

Indiegogo plans to become a funding portal later this year.

Equity crowdfunding “has the opportunity to be a game changer for America, since the last time common people were able to invest in their neighbors was 1932,” Rubin said.

That’s a gross overstatement, of course. Neighbors invest in neighbors all the time on a small scale. Rubin was referring to the Securities Act of 1933, which, in an effort to protect consumers from fraud, set stringent disclosure rules for businesses wishing to solicit equity offers, and limited the amount companies could raise from unaccredited investors.

The new portals are designed to make investing in small businesses as easy as buying publicly traded stock through an online brokerage. By easing the burden for companies to get money from retail investors, the Jobs Act has opened both opportunity and risk. Critics argue that companies desperate for funds will take advantage of naive retail investors after getting turned down by banks and traditional investors.

Proponents of funding portals point to the scrutiny SEC and the financial industry authority have placed on the educational material and warnings investors will see before they put money down. Those caveats may not tamp down the eagerness of new investors to get in on what they see as the next big thing, though.

“The temptation for investors, especially investors who are not used to making these types of investments, is to think they can’t lose,” said securities attorney Jesse Debban, a partner at Farella Braun & Martel. “That’s far from the case.”

Investors must also be aware that private stocks will probably not provide the quick returns seen on the public market, warned Richard Swart, the chief strategy officer at NextGen Crowdfunding, a website that educates investors and connects them with funding portals like Wefunder.

“There are risks, and you have to be able to hold those investments for years,” Swart said. “You can’t track the performance of these stocks. They’re basically illiquid early investment in small companies that in theory could grow, but it’s not a trading stock.”

Investors should not spend money on private equities that they can’t afford to lose, he said.

Would-be unicorns
Tommarello suspects that the businesses most likely to participate won’t be would-be unicorns, who will still seek out sophisticated venture capitalists, nor will individuals flood in seeking to make lottery-style Silicon Valley bets. More likely, he said, the beneficiaries will be the small businesses that he and his eight-person team encountered on a two-week train ride across the country, and the people who want to back them.

In Chicago, the Wefunder team met a rocket scientist working to revitalize his Southside community by creating a “Little Italy for African American cuisine.” A man they met in Cleveland had figured out how to “age” whiskey in one day instead of 12 years, an opportunity opened up by shortages in older vintages.

Those entrepreneurs, Tommarello said, will now be able to seek out investment far and wide.

“The wisdom of the crowd is good,” Tommarello said. “Why should a few guys in suits allocate all the capital? Why can’t people figure out what they want and invest in it?”