SEC moves toward allowing crowdfunding IPOs

Up until now, crowdfunding has just been a way for consumers to give money to inventors concocting newfangled things ranging from Big Wheel bikes for grown-up and smartphones. But soon, it could become a way to actually invest in those companies.

The Securities and Exchange Commission voted unanimously to propose rules that, for the first time, would allow investors to buy stock in companies over the Internet using a crowdfunding exchange. These rules could reinvent the way that companies raise money by allowing them to bypass the traditional costs of going public, which usually involved hiring costly investment bankers and accountants.

The SEC's vote on so-called equity crowdfunding is in direct response to Title III of the JOBS Act, passed last year, in which Congress is looking for a loophole to allow smaller companies to get an exemption from the strict rules controlling the sale of securities to individuals. Congress is hoping that by using Internet crowdfunding, small and promising companies could gather capital needed to grow and expand from a wide pool of investors. These companies could, in theory, raise money they need to grow well before they could afford the relatively high costs of a traditional initial public offering.

The rules would create a new financial entity, called a funding portal, which would be a Web site that would electronically connect investors with young companies looking to raise money. The SEC's approval is needed since such sites are banned today in order to protect investors. Currently, such Web sites would need to be registered with the SEC as a broker, giving the SEC power to oversee the entity. Furthermore, such private sales could only be offered to "accredited investors," or wealth investors savvy enough to know the risks.

With the new rules, the SEC is looking to open the concept of crowdfunding to the public, while still offering investor protection. The new elements of the rules would cap any company's ability to raise money through crowdfu! nding to $1 million every 12 months. Investors on the other hand would only be permitted to invest the greater of $2,000 or 5% of their annual income or net worth every 12 months, as long as their net income or annual income is less than $100,000. For investors with net income or annual income of $100,000 or more, investors would be able to invest 10% of that amount every twelve month period in crowdfunding opportunities. Securities bought through portals would have to be held a year before sold.

The companies selling stock through portals would also face restrictions. Companies would have to disclose details on any investors or officers owning 20% or more of the company. Financial statements of the company's operating history plus a tax return, not to mention details about certain financial dealings between officers and outside companies would need to be disclosed.

Even after the SEC vote, equity crowdfunding doesn't become a reality. There will be a 90-day period for the public to issue comments. The SEC will then review those comments and make a final determination.

The process of approving crowdfunding has taken much longer than most expected as the regulator balances the need to help companies raise capital, but protect investors from scams. Crowdfunding today is rife with examples of consumers donating money to entrepreneurs, only for those people to take the money without ever producing the product or service that was pitched.