Technology

Relaxed rules allow anyone to invest in online startups

The iLet, a “bionic pancreas,” is being developed by Beta Bionics, run by Ed Damiano, a Boston University professor. A crowdfunding drive seeks nearly $1 million to fund the project. The company hopes to give diabetes patients and their families who invest a way to support a device that could help improve their lives, though backers of other projects may be more driven by a desire for profits.

Craig F. Walker/Globe Staff

The iLet, a “bionic pancreas,” is being developed by Beta Bionics, run by Ed Damiano, a Boston University professor.

Buying stock in the next hot startup is usually reserved for people who are already rich. Starting Monday, that’s no longer a hurdle — legally speaking, anyway.

Under federal rules taking effect Monday, private companies can sell shares online to virtually anyone.

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The new system, known as “equity crowdfunding,” opens up more competition for the traditionally clubby world of early stage investing, where people with money and connections bankroll ambitious entrepreneurs.

Dozens of companies are lining up to tap this new source of cash, including Boston-based entrepreneurs trying to build a device to treat diabetes and a website for designing and selling custom jewelry.

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But it may be hard for Main Street investors to get a crack at the next Facebook or Uber. The rules limit companies to $1 million from crowdfunding in a single year. That, coupled with additional regulations, is likely to push the most promising startups toward traditional venture and angel investors.

The idea behind equity crowdfunding is to “create a new kind of stock market” where people can support causes and companies they care about, even if the chances of a big payday are remote, said Nick Tommarello, chief executive of Wefunder Inc., one of several websites that plan to host equity crowdfunding campaigns.

“It’s basically a socially good lottery ticket,” he said. “You make an investment in some early stage company, and it either does really, really well, or it works out badly.”

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That sales pitch caught the ear of Ed Damiano, a Boston University professor and chief executive of Beta Bionics Inc.

Damiano’s company is building a device, known as a “bionic pancreas,” intended to help treat diabetes by adjusting the body’s levels of insulin and glucagon, which help regulate blood-glucose levels.

Damiano began working on early stages of the project after his then-infant son was diagnosed with Type 1 diabetes. The boy, David, is now almost 17, and Beta Bionics is in clinical trials that could eventually result in the device being used by patients.

Beta Bionics is seeking nearly $1 million in a crowdfunding campaign planned to begin Monday through Wefunder. But Damiano is not targeting hungry investors looking to get rich.

Instead, the company hopes to give diabetes patients and their families a way to support a device that could help improve their lives.

“Our intention is to keep this within the Type 1 diabetes family,” Damiano said. “We’re not flipping this, we’re not looking for an exit. And that is very unusual for a medical technology startup.”

A financing drive for the iLet, a “bionic pancreas,” will take place on Wefunder, starting Monday.

Craig F. Walker/Globe Staff

A financing drive for the iLet, a “bionic pancreas,” will take place on Wefunder, starting Monday.

Equity crowdfunding was approved by Congress as part of the JOBS Act of 2012, a law intended to boost high-growth startup companies. The Securities and Exchange Commission spent several years fine-tuning rules for the system.

Under the previous online-investing rules, investors could typically buy shares in private companies only if they made more than $200,000 per year or had a net worth of more than $1 million. Equity crowdfunding vastly lowers those limits, allowing everyday wage earners to buy private stocks through registered broker-dealers or approved online portals.

There are additional barriers in place meant to protect this new class of investors, who might be less able to afford a big loss on a risky startup investment.

People who make less than $100,000 per year can’t invest more than $2,000 or 5 percent of their income or net worth, whichever is smaller. People whose income and net worth are both above $100,000 can invest up to $100,000 per year. A person’s home can’t be counted as part of net worth in calculating those limits.

The system relies on investors to certify they meet those requirements, and fund-raising sites aren’t required to ensure people aren’t fibbing about their finances, Tommarello said.

Nevertheless, Tommarello said, Wefunder plans to monitor investor activity to find users who might be violating the rules.

“We don’t have a legal burden, but we’ll likely put a higher degree of scrutiny on people who seem to be investing a lot, and test a random sample,” he said.

Even with limits in place, some investors could be taken for a ride. The SEC acknowledged the possibility that companies could take advantage of the speed of online fund-raising to fleece the public, writing in a February investor bulletin that “it may be the case that certain opportunities turn out to be money-losing fraudulent schemes.”

And, of course, even well-run companies with good intentions could turn out to be big money-losers.

Doug Melsheimer, a managing director at the Boston boutique investment bank Bulger Partners, said equity crowdfunding is probably a good development for companies seeking non-traditional investment. But for the people writing the checks, it’s “incredibly risky.”

“Investing in publicly traded companies who have lots of regulations and in many cases extensive histories of operations — even those are risky,” Melsheimer said. “So putting capital into a business that has no revenue, that might not necessarily have a commercially available product, is effectively gambling, in my mind.”

Companies that raise money through a crowdfunded stock sale also must publish extensive disclosures about their business plans and finances, which in some cases must be audited by an independent public accountant.

Those requirements can get expensive for small companies. So to keep their legal costs lower and avoid the $1 million annual limit of crowdfunding, some companies may just stick with traditional fund-raising from accredited investors, said Jeremy Halpern, a Boston lawyer who works with emerging companies.

“This will solve a lot of problems, I think, for people in certain kinds of real estate deals or certain kinds of retail deals where they might know lots of people who might put $1,000 or $2,000 to work,” Halpern said. “What’s not clear is if this is a better tool than the existing things.”

Professional investors are keeping an eye on the expansion of equity crowdfunding, even if they’re not immediately threatened. Old-school angel investors have already been using online services to pour money into promising startups, part of a broader trend of technology shaking up the private investment world.

Rob Go, a partner at NextView Ventures in Boston, said that kind of change will ultimately be good for entrepreneurs and the economy. “The industry is moving from a cottage industry to one that is more mature,” he said. “That makes my job harder, but I think that’s a good thing.”

Curt Woodward can be reached at curt.woodward@globe.com. Follow him on Twitter @curtwoodward.
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