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OPINION October 9, 2013, 7:55 p.m. ET
An SEC Rule Change Opens a New Era for CrowdfundingA recent rule change will allow entrepreneurs seeking investors to reach a much broaderaudience.
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By JONATHAN MEDVED
Potential investors will soon begin seeing opportunities pop up in their Facebooknews feeds and in their email inboxes thanks to a major rule change from theSecurities and Exchange Commission. In September, the agency removed thedecadesold ban on public solicitation for private investments. This means privateinvestments can now be marketed to the general public, which will allowentrepreneurs to reach a much broader audience than securities law used to allow.
The nascent crowdfunding market, which uses the Internet to pool small investmentsfrom many investors, stands to benefit significantly from this rule change. Right now,crowdfunding sites like Kickstarter and Indiegogo are not subject to securities lawsbecause they allow people to give money to support projects and individual initiatives,not invest in them. In the roughly four years they've been in existence, these two siteshave raised close to $1 billion in contributions for thousands of projects.
Startups and businesses have taken notice. They have begun to use similar onlinecrowdfunding platforms—but to gather investments. And thanks in part to the SEC'snew rule, the equity crowdfunding market is poised for rapid growth over the nextdecade. Deloitte expects all forms of crowdfunding to hit $3 billion globally this yearand to grow at a compound annual growth rate of 100% over the near term. Equitycrowdfunding is expected to perform even better, with a compound annual growth rateof 114%, according to the crowdfunding advisory firm Massolution.
To be sure, the SEC's change to Rule 506 doesn't allow just anyone to invest. Only"accredited" investors—with a net worth of more than $1 million, or who earn at least$200,000 a year—can continue to participate in equity crowdfunding. The new rulesrequire proof, whereas selfattestment sufficed previously. Many hope that the SECwill issue additional regulations that would let smaller investors get in on the action.
Meanwhile, accredited investors are responding. Equity crowdfunders for accreditedinvestors—including FundersClub, Angelist, CircleUp and my company, OurCrowd—are bringing in tens of millions of dollars for private investments through onlineplatforms. And now that the SEC has removed restrictions on the companies' publicadvertising, sites will at last be able to speak directly to customers.
The resources that might be tapped are staggering. The Royal Bank of Canadaestimates that more than $45 trillion of capital sits in the pockets of highnetworthindividuals worldwide. Roughly $10 trillion is held by about five million U.S.households, according to the privateequity firm Carlyle estimates. Without publicsolicitation or Webbased crowdfunding portals, there was no way to reach beyond asmall percentage of investors.
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This money wants to move. According to April's Northern Trust survey of highnetworth investors, more than half of them are actively seeking new investments. And30% are more inclined to consider alternative investments than they were five yearsago.
A new class of angel investors, affluent individuals who invest personal funds incompanies, is another byproduct of the burgeoning crowdfunding movement. Theseangel investors are no longer just former startup founders. They're a younger, broaderclass of Internetsavvy investors ready to evaluate and pick deals online.
Managing these new angels will require "venture education." Some crowdfunders postnumerous deals and rely on the wisdom of the crowd to weed out the bad ones. Otherplatforms offer limited options to maintain credibility with potential investors. Thispresents some challenges for sound portfolio management. Should angels invest inmultiple private deals to spread out risk and retain enough capital to cover losses?Those running crowdfunding platforms will need to give advice and support to angelsto help them avoid taking big losses on one or two opportunities.
Professional investors know that they must provide value to companies beyond thecapital they invest. Inexperienced angel investors may be less aware of thatobligation. The equity crowdfunding portals will need to facilitate investor involvement.Investors have to find ways to sit on boards and become mentors to help companieshandle growth, hire the right people and make good strategic decisions.
The crowdfunding model allows investing to move beyond Silicon Valley and WallStreet to Main Street. The next generation of angels is likely to include successfuldoctors, lawyers, contractors and realestate professionals who want their share ofthe next Apple or Microsoft. The real question is if government regulation can continueto keep up with this rapid innovation.
Mr. Medved is the CEO of OurCrowd, an equitybased crowdfunding platform basedin Israel.
A version of this article appeared October 9, 2013, on page A17 in the U.S. edition of The Wall StreetJournal, with the headline: An SEC Rule Change Opens a New Era for Crowdfunding.
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