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The Next Level in Crowdfunding

Written By Briton Ryle

Posted February 12, 2015

The next step in the evolution of Crowdfunding has recently received approval in Washington state. The recent enactment enables start-ups and small businesses to raise the capital they need to take their businesses to the next level, while allowing more private investors than ever before to get in on the ground floor to benefit from a company’s future success.

With the passing and signing into law of the new Engrossed Substitute House Bill 2023 in early 2014, and the subsequent changes to regulations which were finally completed at the end of 2014, the financing and investment landscape in the state of Washington have vastly improved for small businesses and investors alike.

The Basic Foundation Under Crowdfunding

To get a better idea of how Washington’s new laws on fundraising improves the financial and investment landscape, we need to start with the basic concept behind crowdfunding.

“Crowdfunding is by definition, ‘the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.’,” Forbes explained when the concept of crowdfunding started blossoming in 2012.

Where a public company is legally entitled to raise working capital by selling shares of its company stock to anyone regardless of their wealth or investment experience, private companies are not so free. The only ways private businesses could raise money would be from family and friends whom the company’s owners have known for a considerable time, or from wealthy high-net-worth individuals known as “accredited investors”.

An accredited investor is defined by Investopedia as “investors who are financially sophisticated and have a reduced need for the protection provided by certain government filings”, who can include “individuals, banks, insurance companies, employee benefit plans, and trusts”. If an individual, they must have either a net income exceeding $200,000 a year, or a net-worth of $1 million or more.

Companies looking to raise capital are not allowed to approach anyone outside of this group of accredited investors, family or close friends. Why? The answer lies in the above definition, centering on “the protection provided by certain government filings”. It’s all about protecting an investor by ensuring enough financial and company information is made available to them to help them arrive at a sound investment decision.

Since public companies are already required to report to the SEC and other government authorities, such vital company and financial information is readily available to investors. But since private companies are not required to file as much information with government authorities, ordinary investors who do not have a sophisticated understanding of business or finance could be easily swindled out of their investments. Hence, private companies have been restricted to soliciting investments only from the more knowledgeable and wealthier sources noted.

Crowdfunding, however, opened the door for private companies to approach unsophisticated, non-wealthy investors, but with certain restrictions. Private companies were still not permitted to sell shares in their company or a venture to unaccredited investors, but they could offer tangible products in exchange for an investment.

For instance, a musician could offer copies of their future album in return for an investment, a movie company could offer a copy of its film, an inventor could offer one of their devices, etc. The point here is that something tangible must be received in return for the investment, which essentially reclassifies the investment as a simple pre-paid purchase of a future item. It is thus not really an investment but the sale of a product.

As early as 2003, crowdfunding websites were already making an impact bridging the gap between small businesses, artists and inventors looking for capital for their next projects and ordinary private investors looking to finance the projects they believed in.

Taking Crowdfunding to the Next Level

As successful as this was, though, there was room for improvement. In an effort to help small businesses gain greater access to investment capital, President Obama signed the Jumpstart Our Business Startups Act (or JOBS Act) in April of 2012, which expands crowdfunding to allow the sale of actual equity in the company, or shares of stock.

For the first time, private unsophisticated investors would be allowed to purchase shares in a private company, offering them a far greater potential return than simply pre-ordering a copy of the company’s latest project or invention, allowing investors’ investments to grow as the company grows. This increases the incentive for investors to invest money in these small private businesses and increase the growth of the small business sector.

Of course there still are some limits on the amount that can be raised from non-accredited investors, such as a $2,000 or 5% annual investment limit for individuals earnings less than $100,000 a year, which increases to a limit of $10,000 or 10% for those earning $100,000 or more. But it certainly widens the pool of investment monies that private companies are permitted to access.

Naturally, it takes a while for such sweeping changes to be incorporated by the various regulatory bodies, such as Securities and Exchange Commission which oversees investment rules and regulations. “As of December 26, 2014,” Wikipedia says, “The Securities and Exchange Commission recently released a rulemaking agenda revealing that it plans to finalize the Title III Equity Crowdfunding rules and the Title IV Regulation A+ rules from the JOBS Act by October 2015. Given that these rules will then require 60 days to be published in the federal register and become law, it appears likely that the earliest date small businesses will be able to utilize these JOBS Act provisions to raise capital will be the beginning of 2016.”

But that hasn’t stopped some states from changing some of their state requirements sooner, including the state of Washington.

Washington State Opens the Crowdfunding Door Wider

On March 11, 2014, the Washington State Senate voted 98 to 0 in favor of the Engrossed Substitute House Bill 2023 which permits the deregulation of multiple restrictions on the sale of equity shares by private companies to non-accredited Washington State residents. On March 28th, 2014, Washington State Governor Inslee signed bill 2023 into law. And on November 1st, 2014, the Washington State Department of Financial Institutions (DFI) released the final rules allowing businesses to begin pursuing equity-based crowdfunding.

The new funding freedoms apply only to companies registered and conducting business in the state of Washington, while the new investment freedoms apply only to Washington State residents. It is estimated that “for 97% of Washington residents, this will be the first time you have been allowed to invest to become a co-owner of an emerging business. In the past, only the 3% of wealthiest Washingtonians were readily allowed to make such investments,” informs Washington Security Exchange (not an actual stock exchange).

Yet there are still some limits, of course, as the bill outlines:

• “The greater of two thousand dollars or five percent of the annual income or net worth of the investor… if either the annual income or the net worth of the investor is less than one hundred thousand dollars”

• “Ten percent of the annual income or net worth of the investor, as applicable, up to one hundred thousand dollars, if either the annual income or net worth of the investor is one hundred thousand dollars or more.”

As the Washington State legislature prefaced the bill, “Start-up companies play a critical role in creating new jobs and revenues. Crowdfunding, or raising money through small contributions from a large number of investors, allows smaller enterprises to access the capital they need to get new businesses off the ground… Helping new businesses access equity crowdfunding within certain boundaries will democratize venture capital and facilitate investment by Washington residents in Washington start-ups while protecting consumers and investors. For these reasons, the legislature intends to provide Washington businesses and investors the opportunity to benefit from equity crowdfunding.”

While other states will undoubtedly follow suit very quickly, entrepreneurs across the country are already eyeing the possibilities that Washington’s new equity crowdfunding bill has opened to them. Already renowned for its strong computer software and digital technology industries, Washington State has just taken another giant leap forward as a state at the cutting edge of innovation and economic development.

Joseph Cafariello