Tag: Entrepreneur Access to Capital Act

Crowdsourcing the Crowdfunding Exemption

There is a growing movement to create a new crowdfunding regime for raising capital. The models seem to draw inspiration from Kickstarter, a platform to fund creative projects. I say that because each time I see a draft bill it talks about an internet-based intermediary as part of the exemption.

President Obama endorsed the idea of a crowdfunding exemption. That has lead to three bills in Congress, plus a proposal being generated by NASAA as a state-run alternative.

President Obama cheered for crowdfunding as part of the American Jobs Act unveiling. The statement talks about the millions raised through Kickstarter in the form of donations. That’s not exactly right. The offering is sometimes a pure donation, but more often is linked to a product in development.

The Entrepreneur Access to Capital Act (H.R. 2930) permits “crowdfunding” to finance new businesses by allowing companies to accept and pool donations up to $5 million without registering with the SEC. It would limit individual investments to the lesser of $10,000 or 10% of an investor’s annual income. An amendment requiring a notice filing with the SEC was rejected as was an amendment that would have barred felons from being involved.

NASSA is putting together a model exemption for use at the state level. The various state level regulators are trying to craft this model.

The Democratizing Access to Captial Act (S.1791) was introduced by Senator Scott Brown. This bill is being supported by the Wefunders, who is in the business of being a platform for capital crowdfunding. Unlike Kickstarter, it’s only open to accredited investors.

Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2011 (S. 1970) was  introduced by Senator Merkley. This bill has the right acronym.

What they all have in common is some cap on the total funds that can be raised and a cap on how much someone can invest.

I’m all for making it easier for entrepreneurs to have easier access to capital. The registration and legal limits on capital-raising deter lots of projects. However, they also vet projects. To some extent, excluding the unworthy. It also tends to deter lots of worthy projects.

I like the project crowdfunding at Kickstarter. There is no expectation of riches, other than whatever trinket or completed example of the project they promise to you in exchange for your funding. I have no concerns about the dilution of shares, executive compensation, ratchets, and follow-up rounds.

Capital crowdfunding should be an interesting experiment. I predict it will create lots of new jobs and fund lots of interesting projects.

I also expect that it will be suspect to fraud. I expect that there will be many disappointed small investors who expected to reap fortunes, instead being stuck with worthless shares in failed companies or companies that existed only to funnel cash to fraudsters.  The extent of that fraud will depend on how well Congress crafts a crowdfunding bill. I expect they will come up short.

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Crowdfunding

It’s hard to raise capital. The regulatory restrictions imposed by securities laws make it harder to do so. As any bright-eyed entrepreneur with a dream project will tell you, the lawyers and the securities laws make it very expensive and time consuming to raise capital for a small project.

The central goal of the Securities and Exchange Commission is to facilitate companies’ access to capital while at the same time protecting investors. More often than not, the securities laws and regulations are put in place due to some prior malfeasance. Limitations on the sale of securities are in place because there were (and still are) lots of shady characters trying to make a quick buck by de-frauding investors.

The Obama administration and the Congress think the regulatory burdens need to be removed to encourage small business capital formation. I’m going to guess that they are fans of Kickstarter, a website that allows entrepreneurs and artists to raise capital for their projects. (I’m also a fan and have contributed to some projects.)

SEC Rule 504 allows a public offering to investors (including non-accredited investors) for securities offerings of up to $1 million. There is no limit on the type of investors, so they need not be accredited investors.  There are no prescribed disclosures and no limitations on resales of the securities. The Rule generally does not allow companies to solicit or advertise their securities to the public.(Of course, the antifraud and other civil liability provisions of the federal securities laws are still applicable.)

However, these offerings are subject to state “blue sky” regulation. That means having to jump through the patchwork of state securities laws, depending where your target investors are located.

How does Kickstarter get around this? It doesn’t. Capital for Kickstarter projects cannot be for securities or lending. As a patron, you do not get your capital returned. Often, you’ll get the end product that the artist or entrepreneur was hoping to produce. (My son is patiently waiting for our pack of trebuchettes to arrive.)

Generally, the term “crowdfunding” is used to describe a form of capital raising whereby people pool money, generally as small individual contributions, to support a specific goal. Since the capital raising did not provide an opportunity for profit participation, initial crowdfunding efforts did not raise issues under the federal securities laws.

The Entrepreneur Access to Capital Act would create a new exemption for small companies, allowing them to raise up to $5 million. The limitation would be that investments are limited to the lesser of $10,000 or 10% of the investor’s annual income.

President Obama cheered for crowdfunding as part of the American Jobs Act unveiling. I failed to find and proposed legislative changes in his proposed bill.

I’m for fueling entrepreneurial growth in this country. I’m concerned that the changes could lead to an onslaught of fraud. I think Kickstarter works well because you are funding the effort. You are not seeing dollars signs.

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