Kickstarter. GoFundMe. Indie-gogo. Crowdfunding websites like these provide a do-it- yourself way to raise money from a large number of people by asking for financial backing. Seeing the potential in this idea, many entrepreneurs have turned to crowdfunding to help launch their startups, usually offering a sampling of their upcoming products in return for contributions.
Now thanks to a recent Securities and Exchange Commission ruling, entrepreneurs can offer more than a gift in return for money. Beginning this May, startups and small businesses can sell equity in their companies through crowdfunding portals. The SEC devised rules aimed at protecting both businesses and investors. For example, companies are limited to raising $1 million per year, and individuals can invest only a certain percent of their income or net worth annually.
“It’s an exciting development in the financing of entrepreneurial ventures,” says Erik Noyes, associate professor of entrepreneurship. “The changes will be disruptive,” he says, “as we are seeing the birth of a new marketplace.” But, on the positive side, entrepreneurs gain an avenue for raising funds.
Dick Mandel, associate professor of law, has been following these rulings. He believes entrepreneurs can benefit from the changes but cautions anyone thinking of going this route. “There are a lot of concerns around these new rules,” he says. “Entrepreneurs are just starting a business, and soon they could have two hundred shareholders clamoring for their attention. They don’t have time to spend placating shareholders—they’re trying to get their business off the ground.”
Mandel also notes that many investors will never see a return on their investment. “Many companies fold or go under in their first few years,” he says. “Others just chug along forever, and a very few get sold off for substantial profit. It’s not clear that there will be an efficient secondary market for these shares.” Generally, people make money on an investment by waiting until the company is sold or by reselling their stock, explains Mandel. But there may be no market for resales of this stock, so the only way out would be to hope for a sale of the company.
Emily Lagasse, MBA’15, founder of startup Fedwell, which makes nutritious dog food, considered equity crowdfunding. “It is an intriguing idea, but the timing wasn’t right for my company,” she says. Lagasse ultimately ended up doing a Kickstarter project, which she felt served her well because it allowed her to personally interact with backers.
Whether this new opportunity proves advantageous for entrepreneurs remains to be seen. Mandel and Noyes advise entrepreneurs to weigh all their financial options before making a decision. Noyes believes equity crowdfunding might be more valuable for businesses that are somewhat established because they have a better idea of potential growth than early-stage startups. “Crowdfunding is here to stay,” he says, “but it’s not a panacea for all companies.”—Alexa D’Agostino