As Equity Crowdfunding Debuts in U.S., Will More Regulations Follow?

Ready or not, equity crowdfunding is coming to the U.S. this spring.

The funding mechanism allows companies to sell shares of their firms to the general public (not just accredited investors) through online portals. The practice has already gained traction in places like the U.K. in recent years, but it has taken a while to arrive in the U.S., as regulators carefully weighed oversight rules.

The SEC finalized those rules last fall, and they’re scheduled to take effect in May. What happens next is still anyone’s guess.

The SEC put in safeguards aimed at protecting inexperienced retail investors from losing their shirts betting on startups, but such investments are inherently risky. Financial technology entrepreneurs and investors, speaking during a panel discussion in Boston Friday morning, expressed concern that when a lot of people start losing money, the SEC might respond with additional regulations that could hamper equity crowdfunding and perhaps have ripple effects throughout the venture capital industry.

“I think there could be some blood-letting, [with] mom and pop investors who lose a lot of money,” said Kent Bennett, a partner with Bessemer Venture Partners. “That could bring more regulations.”

Bruce Wallace, Silicon Valley Bank’s chief digital officer, also fears that “more regulations will come, and it’ll kill the whole thing,” he said.

Traditional venture capital firms invest in a mix of companies in order to spread out their risk and increase their chances of a return. They’ll lose money on most of those bets, but they only need a few (or even just one or two) big wins to be successful. Gareth Jones, co-founder and managing partner of VC fund FinTech Collective, worries members of the public won’t similarly diversify their equity crowdfunding investments. “We as venture investors are taking the portfolio approach to investing,” he said. “It’s not clear whether that message has gotten out to the community of equity crowdfunding enthusiasts.”

On the other side of the table, there’s still skepticism that raising equity crowdfunding rounds will be worth the hassle for startups. Mike Nugent, co-founder and CEO of fintech startup Bison, pointed to music service 8tracks’ Series A round that could generate over $30 million by raising $1,000 each from more than 30,000 individuals. “That’s insane,” Nugent said.

Such an investment would create a “very ugly cap table,” Nugent said. And would executives have to secure signatures from hundreds of shareholders when they want to make business deals or raise the next round of funding? Nugent applauded the potential for equity crowdfunding to help democratize the company fundraising process, “but as a founder and as part of the team, it could be an absolute nightmare to deal with,” he added.

Bennett pushed back on that idea. “I suspect they’ll work that stuff out. That feels like administrative friction,” he said.

Still, Bennett is skeptical that equity crowdfunding will work well for companies that sell products to businesses, because those are more “complicated” investments, he said. But consumer product companies could have success on equity crowdfunding platforms, he said, in part because the backers might be enthusiastic users of the products in which they’re investing. “I think there’s an enormous potential of crowdfunding of products that crowds have good info about,” Bennett said.

The panel discussion was organized by FinTech Sandbox, a one-year-old Boston nonprofit that supports fintech startups and held its latest “demo day” Thursday. Other participants in the panel discussion included Finomial founder and CEO Meredith Moss, Quantopian founder and CEO John Fawcett, and F-Prime Capital associate Doug Nelson.

Jeff Engel is a senior editor at Xconomy. Email: jengel@xconomy.com Follow @JeffEngelXcon

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