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Investing with sense in the new private IPO market

Equity crowdfunding continues to receive a lot of press, but many in the general investing public still don't fully understand it.

Very simply, equity crowdfunding enables individuals to invest in private ventures that raise capital online in exchange for ownership or economic interest.

Despite the headlines, equity crowdfunding is not a new idea—it's an evolution.

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Entrepreneurs and small-business owners have always raised capital from individual investors. In turn, those same investors have long sought out private opportunities. But even as fields as traditional as banking, stock trading and mortgage lending migrated to the Internet, the private-equity fundraising and investing processes couldn't legally occur online.

Under new regulations contained within the JOBS Act of 2012, equity crowdfunding—or, as I prefer to call it, online private investing—is making the private finance market more accessible. But there's an education process that must take place. If you're interested in capitalizing on crowdfunding opportunities, get acquainted with the five basic points below.

1. You need to be 'accredited' to invest, which means ...

Under current SEC rules, only investors who meet certain income or net worth thresholds are eligible to invest in the private ventures that sell their securities through online platforms. If you meet one of those thresholds—generally, a net worth of $1 million (excluding the value of your primary residence) or $200,000 in annual income—you qualify as an accredited investor, according to the SEC.

Why is the "accredited" qualification in place? The JOBS Act, signed in April 2012, included two separate provisions designed to expand investors' access to private opportunities and to increase investors' access to capital. Equity crowdfunding has become the de facto umbrella term for both provisions, even though only one—Title II General Solicitation—is legally allowable at this time.

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General Solicitation allows early-stage companies and other ventures to claim a specific regulatory exemption—Regulation D Rule 506(c)—to publicly advertise their investment opportunities, so long as they meet several conditions. Among them, accepting investments only from wealthy accredited investors. (For issuers not seeking to use General Solicitation, Reg D 506(b) is still available.)

2. And if you're not accredited ...

Title III of the JOBS Act has been hailed as the more "pure" equity crowdfunding provision, designed to allow the general public to participate in private investing. It's a compelling premise that propelled the JOBS Act to pass with rare bipartisan support more than two years ago.

But Title III has hit some snags since April 2012. As consumer protection advocates voiced concerns that it would expose inexperienced investors to too much risk, the SEC took 18 months to draft and release proposed Title III rules. The proposed rules will be challenging to put into practice, could pose high compliance costs to fundraising companies and place new burdens on platforms that would host Title III offerings. How long it will take the SEC to address public comments and implement rules remains unknown.

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Some states—among them Georgia, Kansas, Michigan, Alabama and Maine—are implementing their own "intrastate crowdfunding" rules rather than wait for the SEC. But if you live outside those states (and aren't accredited), you may not be able participate in private investing anytime soon.

3. It's all about access.

To the uninitiated, the Title II exemption doesn't sound all that groundbreaking: Wealthy investors can invest in private companies. They always could … right? So what's the big deal?

The big deal is access. Since 1933, entrepreneurs have only been legally allowed to solicit investments from accredited investors with whom they had "preexisting, substantive" relationships. If you were an angel or real estate investor, you couldn't invest without one of three things: 1) a highly connected network that could introduce you to deals; 2) a ton of free time to spend at demo days and other events to learn about opportunities; or 3) access to funds managed by professional managers, often with high fees and high investment minimums.

Thanks to Title II, accredited investors can—for the first time in 80 years—directly access the private investment market. They can more easily diversify their portfolios through private alternative assets and gain broad, public access to varied opportunities through platforms, like EarlyShares.

It may sound simple, but it's actually a long-overdue update of securities regulations that finally gives the estimated 8.7 million accredited investors in the U.S.—only 3 percent of whom have engaged in private investing—direct access to additional private opportunities.

4. It's not all about investing in the next Facebook.

Much of the fanfare that accompanied the passage of the JOBS Act focused on the new opportunities investors would have to fund start-ups. It's an enticing idea: Come upon a promising young company raising capital online, make an investment, then reap big returns when the business hits pay dirt with an acquisition or IPO.

Part of what's great about the new regulations is that, yes, that could happen. But as experienced angel investors know, start-up investing is very risky, and the wins are usually the only grand slam in a portfolio of strikeouts and base hits. The interesting evolution over the first nine months of 506(c) is that not all online private investing is focused on high-risk start-up investing.

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The Title II rules are opening up investment opportunities in far more than just very young companies—including real estate deals, private-equity funds, small businesses, later-stage private companies, franchises and other entities. All investing involves risk, of course, and returns are never guaranteed. But accredited investors can leverage new regulations to diversify their portfolios in many types of alternative assets—some far less risky than others.

5. Your investments are your responsibility.

Many of the standards accompanying private online investing have yet to be established. Metaphorically, we're in the first pitch of the first inning of the first game of the season.

The onus is on the investor to become educated about new regulations, seek out viable opportunities, understand the risks of investing and make informed decisions.

It's also critical to research the online investing sites with an eye for privacy, security and compliance. Some conduct no due diligence or vetting on deals, functioning simply like bulletin boards. Others act more like venture capital firms, investing alongside "crowd" investors.

Once you find a platform you trust, conduct your own due diligence on each opportunity. Keep in mind that when investing in a private venture, you're becoming part of it. Do its mission and vision align with yours as an investor? Do you believe in the ability of the founder or project sponsor to execute on strategy? Do you understand the industry you're investing in and how the venture can succeed within it? All of these considerations should be top of mind.

By Joanna Schwartz, CEO of online private investing platform EarlyShares, member of the CNBC-YPO Chief Executive Network

Follow her on Twitter @EarlySharesCEO

About YPO

CNBC and YPO (Young Presidents' Organization) have formed an exclusive editorial partnership, consisting of regional Chief Executive Networks in the Americas, EMEA and Asia-Pacific. These Chief Executive Networks are made up of a sample of YPO's unrivaled global network of 20,000 top executives from 120 countries who are on the front lines of the economy. The opinions of Chief Executive Network members are solely their own and do not reflect the opinions of YPO as a whole or CNBC.

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