Last week, millions of more people have been afforded the opportunity to invest in private startup businesses as an equity holder of the company. The Securities and Exchange Commission has signed off on the implementation of the 2012 Jumpstart Our Businesses Startup Act, which now allows for unaccredited investors (those with less than $200,000 annual salary or $1 million net worth) to invest in startup companies in exchange for the company's equity.
President Obama signed the new Act into law in 2012, leaving the SEC to set forth its rules and regulations for implementing the Act. That took four years, mainly because of the SEC's concern and careful consideration for lower-income individuals placing themselves in financial ruin due to fraud or poor investments. After all, the great majority of startup companies end up failing, making the practice of venture capital historically exclusive to the wealthy and "accredited" investors because they could take the hit. Individual unaccredited investors can now invest $2,000 to $100,000 per year, based on the individual's earnings and net worth, through SEC-approved equity based crowdfunding websites.
Crowdfunding itself is not a new concept. Individuals have long since been able to contribute money to startup companies on crowdfunding sites such as Kickstarter and Indiegogo, regardless of their income. However, "investing" on these websites would not give the investor a stake in the startup, but rather promise perks to the investor, such as a novelty item or a meet and greet with the founders.
Starting today, however, equity based crowdfunding websites will allow anyone to become stockholders in a startup business through approved websites. And the difference between purchasing a t-shirt and purchasing shares in the company is huge. Are you investing in a corporation or limited liability company? Has the entity been formed yet? Have you been provided a copy of the bylaws or operating agreement? What fiduciary duties does the company's management owe to you? Do you have a voting interest? Is your stock preferred stock or common stock? Can you get elected to the board of directors? Are you entitled to dividends, and how are they taxed? From a corporate law and tax law standpoint, equity based crowdfunding opens a proverbial can of worms and presents issues that the typical investor on these websites may not ever consider prior to making the decision to invest.
These potential issues are certainly not a reason to shy away from equity based crowdfunding - investing into a company you truly believe in can be a rewarding experience and the new crowdfunding rules give you the freedom and power to make some interesting investments. However, considering the risky nature of startups and the strict formalities of being a company equity holder, carefully vetting investment opportunities and discussing them with an attorney can keep you best advised of what you're looking at with a particular investment.
Eric C. Turnbull is an associate in the firm's litigation, business law and governmental law practice groups. Eric also handles trademark prosecution matters at the firm. He is a member of the Macomb County Bar Association and Michigan Intellectual Property Law Association.