Mom and pop crowdfunding for startups is about to become a reality.
That's good news, but it also comes with a lot of red flags.
On Friday, the Securities and Exchange Commission is expected to issue a final rule regarding Title III of the JOBS Act. This will allow small companies to directly raise debt or equity capital from friends, family, and interested investors.
The SEC has taken three years to consider what they are doing, and with good reason.
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In 2012, Congress passed the Jumpstart Our Business Startups Act, known as the JOBS Act. One of its provisions allows new businesses to raise capital from directly from private investors.
Any investors.
This is a radical idea. Since the 1930s, only "accredited" investors — those with $1 million in net worth or who earn at least $200,000 per year — were allowed to invest in startups.
In other words, only rich people could get in on these private equity deals.
That's about to change. Title III of the JOBS Act would allow individuals to invest money in startups regardless of their income or net worth. Think of it as Kickstarter for non-public companies. Crowdfunding for the masses!
At the heart of this game is a new way to invest: equity-based crowdfunding. But it's different than Kickstarter. When you invest in a Kickstarter project — a movie, for example — you don't have equity in it. You only get a reward, like a copy of the movie.
With equity crowdfunding, you receive an ownership stake, just like a stock. You get a share of the profits.
Title II of the JOBS Act went into effect in 2013. Early stage companies could advertise that they are accepting investors, which they could never do before.
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More importantly, the equity crowdfunding sites went active, seeking to match up startups and private investors.
But up until now these sites have only allowed "accredited" investors. Now, under Title III that is about to go into effect, everyone will be able to invest.
It sounds terrific, doesn't it? Why should only rich people investing in hedge funds and venture capital firms and angel investors be allowed to get in on the future Ubers of the world?
On the day Google went public, for example, early private investors made 3,000 percent on their money, according to Crowdability. Ebay investors made 765 times their money on the first day.
How about the little guy getting in on all this moolah?
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Here's the problem: The potential for higher returns also involves higher risks. Like, you could lose all your money because you invest in a business or technology that never gets off the ground.
You hear a lot about the big successes like Google, but you don't hear much about the failures. And there are a lot of them.
This raises very serious questions about whether investors will be sophisticated enough to understand what they are investing in. Will these new, exciting ways to invest in startups undermine retail investor protection?
This was one of the main reasons the SEC was created in 1934. It was entrusted with protecting investors from getting involved in "unregulated private investments," which caused a lot of investors to lose their shirts back then. That's why the SEC created rules that only "accredited" investors could invest in these private deals. The "accredited" investors were supposedly more sophisticated.
The argument to allow anyone in today is based on the idea that information — via the Internet — is much more widely available today than it was in the past.
On the surface, this is true. There are already many crowdfunding portals that discuss equity crowdfunding, often by specialized topics like tech or biotech.
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Many provide education and research on startups for their subscribers, host training sessions, and publish research reports.
Enactment of Title III of the JOBS Act will greatly increase interest in those sites.
You could see why there is a lot of excitement about this. Leveraging the Internet to grow companies. Job creation. Wealth creation. Less red tape. Less costly regulation.
But you can also see why the SEC has taken three years to look carefully at this. What rules will they enact that will provide adequate protection from shysters and prevent accusations that the SEC is not fulfilling a core mandate?
Want to learn more? CNBC has its own real-time equity crowdfunding index, created in partnership with Crowdnetic. You will be able to find the top funded U.S. companies actively crowdfunding, across all sectors and broken down (sliced and diced).
There's also a wealth of recent articles about crowdfunding efforts in personal loans, hotels, even the art market.
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Browse through the companies covered in the index and you'll read about Seal (developing wearable drowning detection devices), Swingbyte (Bluetooth-enabled devices to allow golfers to analyze their golf swing), Net Zero Aqualife (sustainable, super-intensive shrimp production), and Playground Sessions (music learning software, co-created by Quincy Jones).
CNBC's special reports page on crowdfunding is live now, with real-time indexes.
Luan Cox, CEO of Crowdnetic, will appear on "Power Lunch" today at 1:20 p.m. EDT.