Massachusetts Secretary of State William Galvin has formed a watchdog unit to monitor the emergence of crowdfunding websites that are designed to let start-ups raise money from unaccredited investors.
The Internet Crowdfunding and Offerings Watch Department, or I-CROWD, will be part of the Massachusetts Securities Division and be tasked with monitoring the evolution of sites that could soon let upstart companies use the reach of the Internet to sell securities to raise investment money.
Crowdfunding sites such as Kickstarter are already popular on the Web, but those sites do not allow companies and entrepreneurs to sell securities directly to consumers. However, in 2012, President Obama signed the Jumpstart Our Business Startups Act that requires the Securities and Exchange Commission to devise regulations that will allow private companies to use crowdfunding to solicit investors and make other changes that would give companies access to a larger pool of backers.
In response to part of that law, the SEC earlier in July issued new rules that remove a ban on advertising the sale of securities, setting the stage for companies to use the Web, social media sites such as Twitter, and other means to sell securities. The rule takes effect in September.
The SEC has not yet issued rules for securities sales on crowdfunding sites and has not indicated when those regulations will be published. The popularity of crowdfunding has grown on the Internet and has been a means for artists, inventors, and musicians to use the Web to raise money from supporters, usually in exchange for getting an early copy of the proposed product.
Kickstarter is the best known site, but the company has said it has no plans to let start-ups raise investment capital via the site.
One big issue for investors is that the securities from those firms are not subject to the same level of oversight and disclosure as those of publicly traded companies, meaning investors would have limited information about the company and its finances.
Concerned about amateur investors being duped into bad investments, Galvin said it was crucial to have a monitor watching as the industry develops — especially with the ban on advertising ending in September.
“The concept of general advertising in this area troubles me,” Galvin said. “There’s always the potential for people to make bad investments, the problem I have is that [investors] aren’t going to know what they are investing in.”
Under current regulations, investors who make direct investments in start-ups have to be accredited, which means they must have a net worth of more than $1 million or an annual income of more than $200,000. The JOBS Act called for changing those rules so that investors who earn less money are able to make small investments of several thousand dollars in start-ups. Under the law, start-ups cannot raise more than $1 million over a 12-month period.
Several new companies such as CircleUp Network Inc. of San Francisco already operate websites for accredited investors to invest in start-ups and are poised to take advantage of the SEC changes. Still, Rory Eakin, a founder of CircleUp, said the company is waiting until the securities regulations are issued before it commits to becoming a crowdfunding platform.
However, because of the new SEC rules, his company may soon begin to publicly display the names of companies using CircleUp to raise money. Now, those companies can be viewed only by accredited investors who register with the site.
Changes associated with the JOBS Act do have the potential to create a sea change in the way start-ups raise money, and to give many more people the chance to buy in to early-stage companies.
That could be a boon for many fortunate investors if those start-ups become the next Instagram, the photo-sharing app that Facebook bought for about $700 million, but those sorts of Internet successes are rare.
“These are highly risky investments,” said Matthew Witheiler, a principal at Flybridge Capital Partners, a venture capital firm headquartered in Boston. “People will be potentially hurt if expectations aren’t met.”
Michael B. Farrell can be reached at firstname.lastname@example.org.