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A stake in the next big thing
In the UK, crowdfunding is no longer restricted to making a monetary contribution for a social or creative cause but actual investments (in return for equity shares) can be made in entrepreneurial ventures. This will shortly be a reality in the US too.
In July 2012, UK’s Financial Services Authority approved the first online funding platform — Seedrs, which acts as the intermediary between the entrepreneur and the crowds of investors. Individual investors can invest as little as £10 but to mitigate risks they cannot invest more than 20 per cent of their declared net assets in aggregate through Seedrs (unless they are self-certified as high net worth or sophisticated investors). Entrepreneurs can raise up to £150,000 and are given a three-month period to raise their targeted initial seed capital. If this amount is not raised, investors get their money back and if the target capital is raised, the startup has to issue ordinary shares, which are held by Seedrs as a nominee of the investors. This ensures that the entrepreneur is not bogged down with investor relation issues.
Within a month of Seedrs going live, three startups achieved their target capital (much earlier than the available three-month window). Digital Spin raised £60,000 (for a 15 per cent equity share of the Company); PlayBrighter and Satago raised £30,000 each (for a 8 per cent and 14 per cent equity share of the company, respectively).
“Tax benefits for investments in eligible startups under the newly introduced Seed Enterprise Investment Scheme, which provides an up-front tax relief of 50 per cent of the investment and no capital gains on sale of shares after a three-year holding, could also have boosted enthusiasm for crowdfunding,” points out a UK-based tax advisor.
The Jumpstart Our Own Business Startups (JOBS) Act was signed by Presided Obama on April 5, one of whose provisions facilities crowdfunding against issue of shares, enabling entrepreneurs to raise up to US$1,000,000 in any 12-month period. The internet funding portal that is used for crowdfunding will need to be registered with The Securities Exchange Commission (SEC). To mitigate investor risks, caps have been imposed. For instance, if the investor’s annual net income or net worth during a 12-month period is less than US$100,000, such a investor can only invest 5 per cent of such amount or US$2,000, whichever is higher. At the other end of the spectrum, investors with an annual income or net worth of more than US$100,000 are allowed to invest up to 10 per cent of their annual income or net worth, up to a maximum of US$100,000.
“From the entrepreneur’s perspective, crowdfunding offers an easy-access , low-cost , low-risk method of raising capital. Setting up a project on a crowdfunding site is relatively easy, and is accessible to entrepreneurs who may not have access to traditional angel or VC investors. On the other hand, the JOBS Act, unfortunately, limits crowdfunding by imposing arbitrary investment caps per investor, total investment caps per project and burdensome information requirements,” explains Aron Izower, New York-based partner (Corporate and Securities Practice) of global law firm Reed Smith LLP.
At present the SEC is working towards greater investor protection and bylaws will be issued (it has a nine-month window from April to do so). “The SEC should look to the social media structure as the firstline of investor protection. Web-based crowdfunding is a social media phenomenon, and relies on the feedback and interplay among online groups. The SEC should make sure that this exchange of information is encouraged and easily accessed on crowdfunding sites, so that potential investors can be informed about a project and entrepreneurs. At the same time, the SEC should not over-regulate or require costly disclosures ,” suggests Izower.
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