When the JOBS Act passed last spring, there was a huge surge on the future of crowdfunding. In pursuit of the riches of startup investing, many ignored the already successful world of Kickstarter, Indie Go Go, and others that already successfully fund projects. Those platforms don’t show the investor a pot of gold at the end of the rainbow. They show the investor the final project and maybe the chance to purchase one or participate.
By switching to equity fundraising, the focus would switch to the potential financial reward and perhaps less on the value of the project. Critics wailed about the onslaught of fraud. Proponents praised the unleashing of entrepreneurial capital. The lawyers and regulators worried about how to implement this new capital raising regime.
Congress didn’t make it easy. They chose do throw out the original crowdfunding law proposed for the JOBS Act and replaced it with a very cumbersome and difficult new piece of legislation. They gave the Securities and Exchange Commission 270 days to come out with the regulations. That’s on top of the huge pile of regulatory mandates passed 2 years ago with Dodd-Frank.
We have seen no inkling that the SEC has come close to proposed regulations. With the departure of Mary Shapiro, the SEC is down to four commissioners. Two of whom have publicly voiced their concerns about crowdfunding. Even if the SEC can gather three out of four of the commissioners to agree on proposed regulations, there will be a lengthy comment period and likely re-writing to get to the final regulations.
In addition to the SEC, FINRA will need to create a regulatory regime for the registration of crowdfunding portals. To get a taste of how difficult this going to be, you can take a look at the first baby steps of regulatory work that came from FINRA.
FINRA is inviting prospective crowdfunding portals to voluntarily file an interim funding portal form. The filing is meant to help FINRA develop rules that reflect the funding portal community and its business. It is not an application and does not get anyone any closer to having a working equity crowdfunding platform.
For a taste of the difficulties take a look at the last question:
Please describe how the [Funding Portal] addresses the requirements for funding portals under the JOBS Act. In particular, please describe how the [Funding Portal] would
(i) address investor education;
(ii) take measures to reduce the risk of fraud with respect to funding portal transactions;
(iii) ensure adherence to the aggregate selling limits; and
(iv) protect the privacy of information collected from investors.
The successful crowfunding portals are going to have to master difficult regulations, successfully court attractive investment opportunities, master the 50 states of privacy legislation, come up with effective investor eduction tools, and successfully attract investors willing to write checks.
I still think crowdfunding will end up being a minor league system for the investment banks. They have the resources to conquer these hurdles. They can use the database of investors to mine for more conventional investment opportunities. They can use the few successful crowdfunded companies to sell bigger opportunities for raising more capital. It seems to me that we are still many, many months away from seeing the first crowdfunding portal under the JOBS Act.
Sources:
- FINRA Releases Interim Form for Crowdfunding Portals by Vanessa Schoenthaler in 100 F Street
Doug, I am persuaded that you are right that the investment crowdfunding exemption, as legislated, is destined to be a pipeline for entry level financial “products.” I quote you often to this effect.
And that is sad.
I think those who were looking to investment crowdfunding to be something to empower small businesses and local communities should stop wasting their time following the Title III rulemaking process (or lack of it) and ask Congress to try again.
The JOBS Act was never an integrated masterpiece of policy. It’s only after that fact, when we compare Title II to Title III, that we can see that the real investment crowdfunding under the JOBS Act is in Title II. And that crowdfunding architecture is restricted to accredited investors.
If the country wants to experiment with investment crowdfunding that involves all Americans (something the President celebrated at the JOBS Act signing ceremony in April 2012), it should copy the angel platform playbook. The one difference between the two should be that non-accrediteds should be subject to an annual investment limit . And that limit should be policed using the Individual Crowdfunding Account (avoiding the cognitive dissonance of points (iii) and (iv) of the FINRA question you quote above).
I agree that there is unnecessary complexity in the legislative framework for company crowdfunding. But, the question will be “what to do when investors get angry about a failed company?”
We are already seeing some of that shakeout in Kickstarter projects that are missing production deadlines or disappearing with no delivery.Those problems will just get magnified with company crowdfunding. The investors will be armed with shareholder rights of action and legal recourse that they largely lack with Kickstarter.
You and I realize that this kind of investing will result in a total loss 90% of the time, a little return sometimes and rarely a big return. I fear that company crowdfunding will sold on the rare successes.
Contrast that with the Kickstarter approach of funding worthy projects merely because you like the project. Maybe you get a product at the end of the day or some schwag. But you don’t have any dream of using the contribution to get rich.