F-U-N-D-E-D: New rules mean you, too, can be a startup owner

Beginning Friday, crowdfunding sites like Kickstarter and Indiegogo can give the public the chance to be startup owners, not just donors.

Max Taves Staff Reporter
Max writes about venture capitalism and startups while seeking out the new new thing to come out of Silicon Valley. He joined CNET News from The Wall Street Journal, where he contributed stories on commercial real estate, architecture, big data and more. He's also written for LA Weekly, Slate and American Lawyer Media's The Recorder, where he covered legal battles in Silicon Valley. Max holds degrees from Georgetown University and Columbia University's Graduate School of Journalism.
Max Taves
4 min read

New investor rules open ownerships of startups way beyond Silicon Valley venture capitalists. Jurgen Ziewe / Ikon Images

So you want to be the next Marc Andreessen? Friday could be the day when you start trying.

New federal rules will allow the American public at large to go online and buy shares in startups. Up to now, that hadn't been a legal option for any but the richest 3.5 percent of US households, including Silicon Valley venture capitalists like Andreessen, whose pedigree in tech stretches back to the earliest days of the Web.

And the changes made by the US Securities and Exchange Commission aren't just opening up investment opportunities to the masses. They could also give startup founders a reason to bypass Silicon Valley's all-powerful venture capital firms.

A law that went into effect in 2012 -- the JOBS Act, which took its name from the phrase "jump-start our business startups" -- had eased Depression-era federal rules governing how companies raise funds and sell shares, providing a shot in the arm for crowdfunding.

But the law's effect had also been blunted by rules that, among other things, have restricted the buying and selling of shares in private, non-publicly traded companies to accredited investors -- that is, individuals whose annual income is greater than $200,000 or a household whose net assets (excluding their homes) exceed $1 million.

Although Kickstarter and Indiegogo have been increasingly valuable avenues for tech entrepreneurs to raise cash, those crowdfunding platforms have only offered the digital masses the chance to be donors, not owners. Give $10 to a boutique yarn store in Pennsylvania you found on Kickstarter, expect a tote bag, not a share.

And while other crowdfunding sites like Wefunder have allowed tech entrepreneurs to sell pieces of their startups online, circumventing the traditional venture capital route, the SEC has effectively kept 96.5 percent of American households (that is, the non-accredited investor population) from being able to buy, sell, or even look at, the investment opportunities on their sites.

"Unless you're a rich person, you can't participate in the next Facebook or Apple or Tesla," says Ron Miller, CEO of StartEngine. "Friday opens that up."

Miller is banking on it.

Founded in 2011 by Howard Marks -- co-founder of video game giant Activision -- Los Angeles-based StartEngine has been a tech accelerator, helping more than 60 startups try to grow from startup to behemoth in exchange for a cut.

But because of changes to the JOBS Act made by the SEC, StartEngine launched a crowdfunding platform Friday, allowing anyone -- not just venture capitalists or just wealthy, connected individuals -- to buy shares in startups.

For its part, StartEngine is starting slowly, only offering potential investors two young companies: Elio Motors, a transportation startup that's seeking to manufacture an ultra-high-mileage two-seater car that it expects to sell for about $6,800; and XReal, a sports-focused mobile-game publisher founded by Jordan Maron (aka CaptainSparklez on YouTube).

'A step in the right direction'

But even though the SEC changes will ease the process for equity-focused crowdfunders like StartEngine to raise money, patience will still be a virtue. Even after potential investors express interest in, let's say, buying shares in XReal, Miller says it could take between three and five months before the SEC allows the company to actually release shares.

Still, Miller is hyperbolic about the long-term significance of the changes that go into effect Friday.

"We see it as the greatest advancement in entrepreneurship in a generation," he said.

That remains to be seen. Today, founders, venture capitalists and securities lawyers are guarded in their expectations and optimism, and neither of the two biggest crowdfunding platforms -- Kickstarter and Indiegogo -- have plans to change their current donor models toward investing.

For its part, however, Indiegogo appears to be open to the idea of allowing for investing. Its CEO and co-founder, Slava Rubin, told CNET that Friday's change is "a step in the right direction." He said, "We're definitely interested in equity crowdfunding."

Of course, there are still many potentially complicating factors.

The costs of complying with federal and state securities rules still aren't incidental: StartEngine expects that it will cost a company looking to sell shares via crowdfunding between $40,000 to $50,000 in regulatory expenses.

And states aren't rolling out the welcome mat. On Tuesday, the SEC denied Montana's recent attempt to prevent the rules from going into effect. And Massachusetts has filed a still-pending motion to block it.

And there's also the quality problem.

"This is a hugely symbolic day," says Wefunder's Mike Norman. Norman says his crowdfunding company will eventually offer nonaccredited investors a chance to invest in startups. However, he worries whether there will be enough startups with solid business models and competent teams attracted to raising equity via the crowd as opposed to the expertise -- and clout -- often offered by venture capital firms.

"Are [these rules] structured in a way that good companies will take advantage of them?" he asks.

And then there's the other problem: picking winners among startups isn't easy.

Ask Chris Dixon.

Dixon, a general partner at venture capital firm Andreessen Horowitz, has had his share of successful picks, investing in startups such as Pinterest, Foursquare, Skype and even Kickstarter. But he's got sobering advice to those expecting to back the next Google, Facebook or Instagram.

"We're in the hits business," says Dixon. "Most of the time you get flops, but sometimes you get a hit."

Adds Dixon, "I think if done right it can be very promising, but I just hope people know the risks they're getting into."

F-U-N-D-E-D is part of a regular column looking -- and sometimes laughing -- at what Silicon Valley has backed in the last week.