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New Crowdfunding Rules Let the Small Fry Swim With Sharks (NYT)

If you’ve always dreamed of being Mr. Wonderful from “Shark Tank,” now is your chance.

Starting Monday, new rules will permit anyone, not just the moneyed, to risk $2,000 a year or more investing in small companies in exchange for a stake in the business. Companies can raise up to $1 million a year this way.

By STACY COWLEY    MAY 14, 2016

This change, years in the making, represents an enormous shift, one that essentially permits anyone to become a venture capitalist — with all the attendant risks of losing one’s shirt on a company that fails. Until now, only accredited investors, meaning those with an annual income of at least

$200,000 or a net worth of at least $1 million, have been permitted to take equity stakes in most private companies. The wealthy “sharks” of the ABC reality television series got to risk their money, while the rest of us watched the action from the couch.

It is also an opportunity for start­ups and other small businesses, which can raise money with fairly few regulatory burdens. For instance, small companies seeking less than $500,000 and most first time issuers will not need to provide audited financial statements, just unaudited ones.

“For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in,” President Obama said when he signed the bill into law that set these changes in motion.


That was four years ago. It took a long time to iron out the details, in part because the Securities and Exchange Commission was concerned that ordinary people could lose their life savings because of fraud or naïveté.


That remains a fear for many in the financing industry. Samuel Asher Effron, a lawyer with Mintz, Levin, Cohn, Ferris, Glovsky and Popeo who specializes in securities law, thinks the companies that choose to crowdfund will largely be those that are passed over by professional investors.


“When high growth companies are looking to raise money, it’s not just for the money,” he said. “They’re also looking for validation, and they want it from venture funds or well­known angels. They won’t get that from a crowdfunding offer.”


But one entrepreneur who is eager to take advantage of the new rules is Kelechi Anyadiegwu, 26, who started Zuvaa, an online marketplace of African fashions, two years ago. Her website is a portal where African­inspired designers from around the world can market their wares, which recently included a $120 office­appropriate dress from Tanzania and a $55 Lycra dashiki party dress.


When sales recently topped $1 million, she said, she started thinking about expanding. So far she has been relying on pop­up retail events, networking, and Instagram and Facebook accounts that now have more than 100,000 followers.


“We’re building a tribe of women around the world who are passionate about African textiles and want to support these emerging designers,” Ms. Anyadiegwu said.





It occurred to her that those women might be interested in buying not just dresses and textiles but also a piece of the company. Ms. Anyadiegwu has been talking to SeedInvest, one of about a dozen companies poised to serve as middlemen in the emerging business.


Ms. Anyadiegwu wants to increase her part­time workers’ hours, move her base of operations from Sayreville, N.J., to Atlanta, where she has built a clientele, and do more marketing. To finance that, she’s willing to part with some of her equity in the business.


“Our customer base is so engaged,” she said. “This could be a perfect opportunity for them to participate and be a part of the company in another way.”


Another company thinking about taking this route is Rorus, a technology start­up in Pittsburgh that makes water filters for developing countries. It has already raised nearly $300,000 from rich individuals and traditional venture capital funds, but the founders like the idea of building a larger circle of investors who act as advocates.


“We can build a community around our company. That’s an intangible that you don’t get from private fund­raising,” said Kyle Henson, 23, the company’s chief business officer. He is preparing Rorus to comply with the new securities rules, he said, if it chooses to do a crowdfunding offering.


But are the 230 million adult Americans who aren’t millionaires really that interested in becoming do­it­yourself venture capitalists? While supporters cheer the new rules as a democratization of high finance, potentially opening up to the masses deals once reserved for the rich, skeptics worry that regular investors might get only the leftovers.


They may dream of discovering the next Facebook. But the most promising companies — the high­growth ventures delivering the monster returns that keep the entire venture­capital industry afloat — may also be the





ones least likely to bother raising money in small dribs from the crowd, they fear.

Finding ‘Blockbusters’

The shift toward the new rules began more than four years ago, when President Obama signed the Jump­Start Our Business Start­Ups Act, a bipartisan bill that he called a “potential game changer” for fledgling businesses. The bill itself is a slender 22­page document ordering a number of technical changes to ease fund­raising for small companies.

But what got people excited was the crowdfunding provision allowing companies to raise up to $1 million with few regulatory obstacles.

Sounds simple, right? Not to the Securities and Exchange Commission. Concerned about protecting investors from charlatans, bad ideas and their own poor judgment, the agency spent years drafting its proposed rules. The final version, released in October, runs to 685 pages.


The new rule, known as Regulation Crowdfunding, allows most private companies to advertise shares for sale to anyone, regardless of income.

Individual investors can invest $2,000 to $100,000 a year in crowdfunding offerings, depending on their earnings and net worth.

The option appeals to Bhree Roumagoux, 42, and Robert Hensch, 46, a married couple in Anchorage who make a hobby of tracking early­stage technology ventures. They recently sank a five­figure sum into buying shares in Virtuix, a privately held start­up in Austin, Tex., that is developing a virtual reality motion platform for gaming.

The company caught Mr. Hensch’s eye nearly two years ago, after it raised

$1.1 million on Kickstarter. He scoured tech blogs for tidbits, signed up for the company’s newsletter and followed along as executives posted updates from China about their production process.

So when Virtuix announced in March that it would crowdfund its next investment round, Mr. Hensch and Ms. Roumagoux jumped in. “I’ve seen where Robert’s recommendations have gone in the market. Typically, when he identifies something early on, it becomes a blockbuster item,” said Ms.

Roumagoux, recalling her husband’s early enthusiasm for Tesla, Netflix and a “really neat” search engine called Google.


Ms. Roumagoux works as a lawyer, and Mr. Hensch is a real estate business manager. As financiers, “we’re definitely novices,” she said with a laugh, but both like the idea of diversifying their retirement fund and other investments by gambling on a small portfolio of fledgling technology ventures.


Jan Goetgeluk, Virtuix’s founder and chief executive, likes the idea of having hundreds or thousands of stakeholders along for the ride. “This allows us to turn those fans into true brand advocates. It’s incredibly powerful.”


Mr. Goetgeluk, a 32­year ­old mechanical engineer, had dreamed of becoming an entrepreneur since moving to the United States from Belgium nine years ago. The money he raised from 3,000 backers on Kickstarter funded Virtuix’s early production, and the publicity the campaign created got him a spot pitching his company to a panel of rich investors on “Shark Tank” — where he failed to land a deal.

“If my husband brought this into my house, I would divorce him immediately,” Barbara Corcoran, a real estate entrepreneur, announced on the show.

Still, Mr. Goetgeluk went on to raise $8 million in two seed rounds from venture capitalists and wealthy angel investors, and an additional $4.7 million from a more complicated — and much more expensive — previous program for selling stock to regular investors.

The rules that take effect on Monday make crowdfunding far cheaper and easier for companies to use. But the cost of that concession is a $1 million cap on the amount they can raise in a 12­month period.

Cautionary Tales

To promote their offerings, companies will have to work through a funding portal, a kind of online bazaar for investment deals. More than a dozen websites are preparing to enter the business, including CrowdBoarders, FlashFunders, NextSeed, SeedInvest, StartEngine and ZacksInvest.

Wefunder, one of the first to get a green light from regulators, says it will have around 20 live offerings on Monday. It’s a day the site’s creators, Mike Norman, Greg Belote and Nick Tommarello, thought might never come. They started their company in 2012, and then they waited.

“We had no idea that it would take the S.E.C. four years to write all these rules,” Mr. Tommarello said. “We had to figure out how to stay alive and not go bankrupt.”

To make money, the site started hosting Regulation D offerings — the kind only wealthy people can invest in. Some of those deals turned into cautionary tales. In 2013, the human resources start­up Zenefits raised money from Wefunder investors, who bought in at a valuation of $9 million. Two years later, the company’s valuation had sailed past $4 billion.

And then, three months ago, Zenefits imploded. The company’s founder and chief executive, Parker Conrad, stepped down after it was discovered that he had created software that let Zenefits employees cheat on a brokerage licensing course. Zenefits is being investigated by regulators in several states, faces fines that could total millions of dollars and risks even stiffer penalties. A valuation is hard to calculate on that kind of mess, but it’s safe to say that the $4 billion days have passed.

Many start­ups that take crowdfunding money — probably most — will fail. Half of American small businesses close within their first five years, and even successful companies usually struggle through many lean years before generating meaningful profits.

That’s one reason the S.E.C. moved so slowly. “We are counting on brokers and funding portals to be bulwarks of investor protection in this space,” Mary Jo White, chairwoman of the S.E.C., said in a recent speech. “We will hold them to that responsibility.”


Still, this isn’t like investing in the stock market. Want to sell Facebook? Just call your broker. Want to sell your shares in Ms. Anyadiegwu’s company, Zuvaa? Well, under the new crowdfunding rules, people must generally hold their shares for at least a year. And even then, there are few marketplaces for finding another buyer.

Virtuix’s offering circular, which is a more detailed document than is required from companies using the new rules taking effect this week, is full of warnings. The company has not finished its commercial product, has little revenue and has a history of losses. It also has a “going concern” notice — the warning auditors put in when they’re not sure that a company has enough cash to survive.

But Ms. Roumagoux, who said she had skimmed the circular, isn’t worried. She and her husband may not be millionaires, but she says they’re financially sophisticated enough to judge the risk that they’re taking.

“I know all these rules are there to protect us, but honestly, I don’t think we need the protection,” she said. “We’re relatively young, and this is a long­ term investment.”

Read More at the New York Times

A version of this article appears in print on May 15, 2016, on page BU1 of the New York edition with the headline: Now the Small Fry Can Swim With Sharks.