By Mike Panesis
The unfortunate events in our nation’s capital in early January had me thinking a lot about revolutions.
Whether successful or not, they seem to come upon us suddenly, when in fact they have fomented for years. We see this phenomenon not just in government and society. In the groundbreaking book “The Structure of Scientific Revolutions,” author James Kuhn makes a similar observation about science: long periods of incremental discovery punctuated by generational paradigm shifts that change the way we see the world.
I believe that we may be on the verge of a revolution in the way that we fund startups that has been years in the making and has deep social implications.
As the primary regulator of capital markets, the U.S. Securities and Exchange Commission lists investor protection as its first duty. The SEC takes two different approaches to protection for public and private capital markets. We all know the public markets. Anyone can open a brokerage account and be trading stocks in no time. Investor protection takes the form of strict financial and reporting requirements and a code of conduct for industry professionals.
The SEC protects private investors differently. There are fewer rules and much more risk. To make private investments freely, you must be accredited. “Accredited” sounds like it involves intense study and passing a certification test, but all it really means is that investors meet certain very high income and wealth requirements. The rationale is that the wealthy can afford to take big risks and lose an entire investment.
This kind of protection is effective, but it is dramatically exclusive and contributes to systemic racism. One need only look at the ranks of private equity, venture capital and angel investors—usually white and male.
I am hopeful that the complexion of traditional private investment will change, but I believe that there is a new way of investing privately that is much more inclusive and beneficial for startups. The Jumpstart Our Business Startups Act of 2012 (remember, revolutions take time) required the SEC to make private investment easier for more people by allowing equity crowdfunding. This kind of crowdfunding is different than Kickstarter and IndieGoGo, which are really about prepaying for a new product. Equity crowdfunding enables equity investment in startups by anyone. The SEC protects the investor by limiting the total amount that an individual can invest to a percentage of personal income.
Equity crowdfunding investments are small, as little as $100, but because they are open to everyone, there are many more investors. For example, rather than raising $500,000 from five accredited investors $100,000 at a time, a startup may raise $500,000 from 5,000 crowdfunders $100 at a time.
The limit to the amount of capital a startup can raise annually through equity crowdfunding recently increased from $1 million to $5 million, a sizable amount for most startups.
There certainly are disadvantages to equity crowdfunding. These still are high-risk investments prone to failure, hopefully offset by enough successes that keep the crowd energized. From the founder’s perspective, dealing with so many investors can be time-consuming. There are technological solutions to this dilemma, though, and raising capital from accredited investors can be equally time-consuming.
I have been an accredited angel investor for more than 10 years and a crowdfunding investor for 18 months. I love traditional angel investing, but here’s what I’ve learned about the crowd: They care deeply about sustainability. They are willing to invest in startups led by female and founders of color both for the quality of the startup and in the name of equity. They are passionate about making a difference in the world. They see value in places that I don’t. It feels new, relevant and exciting.
If you want to learn more about equity crowdfunding, check out platforms like Republic, StartEngine, WeFunder and Microventures. Or head to Kingscrowd for analysis of all crowdfunding deals on the most popular platforms. On your way, pick up a flag, ready yourself for the challenges to come, and look for allies in founders who share your values and passion. This is a revolution for all of us
• Mike Panesis is the executive director of the Steven Dorfman Center for Innovation and Entrepreneurship at California Lutheran University.