Crowdfunding: Dot-com 3.0

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Globe Advisor | Ivor Tossell | March 28, 2014

Dot com 3.0Investing in start-ups, with all its risks and rewards, has been limited to accredited investors. Crowdfunding is about to change that

Before it became the poster child for crowdfunding success, the Pebble Smartwatch struggled to get financial backing. A svelte, wearable computer that stole a march on Apple and Samsung, the wristwatch has an e-paper display, runs apps and does neat tricks like controlling nearby smartphones.

But the idea didn't connect with seed funders, so the Pebble's creator, Eric Migicovsky, turned to Kickstarter. He posted a video on the crowdfunding site asking for donations. In return, anyone who pitched in $115 or more would get a Pebble of his or her own. On a campaign to raise $100,000, the Silicon Valley company walked away with $10 million in donations and orders.

Runaway successes like this are the exception, but crowdfunding can be a good way to gauge public interest in a product. Still, traditional crowdfunding has always had one sharp limitation: The public can be offered almost anything in return for their money - except an actual stake in the company. Securities regulations in Canada and the U.S., designed to keep small-time investors from being taken to the cleaners, have prevented entrepreneurs from selling equity in their new ventures. Investing in start-ups, with all its risks and rewards, has been limited to accredited investors only - in other words, people with piles of money, who regulators are confident are capable of looking after themselves in the open marketplace.

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That's about to change. For what might be the first time anyone's ever been stoked about securities regulations, authorities in the U.S. and Canada are looking to open the floodgates for start-ups to sell stakes in themselves to you, me and most anyone else. "What we'll start seeing is an armchair Dragons' Den - people who want to manage their own portfolios," says Craig Asano, the executive director of the National Crowdfunding Association of Canada. "It will democratize the capital flow."

In the U.S., the new Securities and Exchange Commission rules, which are currently being circulated for comment, would still put tight restrictions on would-be dot-com moguls: Investments would be limited to about $2,000 a year for investors at the low end of the income scale, growing to $100,000 a year for millionaires. Start-ups, for their part, would be limited to raising $1 million a year in equity and, for the first time, will have to cough up information about their plans and revenues (such as they may be) before making an offering.

Similar changes, with roughly comparable caps, are being mulled in Ontario, and the public could get a look at the proposals as early as March. Saskatchewan, for one, has already signed off on small-scale crowdfunding. Canada is a bit more complicated than the States, where securities are regulated federally, rather than province-by-province. But Canada's regulators may well be co-ordinating behind the scenes. "Do not be surprised if it rolls out all the way across Canada at the same time as Ontario, or shortly thereafter," says Alixe Cormick, the owner of Venture Law, a Vancouver-based corporate securities firm.

View:  Saskatchewan approves equity crowdfunding!

In some parts of the world, equity crowdfunding is already a reality: Australia, the United Kingdom and Sweden have allowed it for years; their experiences suggest it has helped the tech industry, if not revolutionized it. But it's the powerhouse of America, with its vast reserves of talent, capital and hundreds of millions of consumers with an unparalleled appetite for getting rich, that's really waiting to get uncorked.

The promise of equity crowdfunding is several fold. Bret Conkin, chief marketing officer of FundRazr, one of Canada's largest home-grown crowdfunding sites (it has raised $37 million in donations in 20 countries), thinks equity will become part of a crowdfunding ladder for start-ups. "You might use donations at the idea stage," he says, "then, you run a perks-based campaign to run a preorder." Afterward, start-ups might use equity crowdfunding to supplant a seed round, where larger investors would have stepped in. Instead of five big funders, a start-up might attract a few hundred small ones. "We view it as a continuum of funding."

The new rules will bring sweeping change to an already-volatile sector - or create an entirely new one. All of a sudden, people who've been reading about the start-up boom from a safe remove will be able to place bets with their own money. From a regulatory perspective, this will put pressure on the portals - the Kickstarters, Indiegogos and Fund- Razrs of the world - to keep their sites clear of fraud and stay neutral, so as not to act as "stock pickers." The finer points of how this will be achieved are of some concern to portal operators. "We hope they'll have the sense to adjust the regulations so that it will be workable for entrepreneurs to raise money in this fashion," says Conkin.

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