On Tuesday (March 27th), the U.S. House of Representatives approved the Senate’s version of the “Small Business Capitalization” amendment to the JOBS (Jumpstart Our Business Startups) Act.  This amendment allows small businesses to use equity-based crowd funding to generate investment into their businesses.

This doesn’t open the flood-gates and create some kind of fund-raising free-for-all that some opponents of the legislation might have you believe is the case.

The amendment, as added by the Senate, is basically similar to the language contained in HR 2930 – the Entrepreneur Access to Capital Act that had previously been passed by the House.  HR2930 was based upon the CrowdFund Investing (CFI) framework created by Sherwood Neiss, Jason Best and Zak Cassady-Dorion.  You can read more about CFI at Startup Exemption.

Once the President signs the JOBS Act this week, the SEC will begin 90 days of rulemaking, and then open their draft rules for 90 days of comments.  In addition, the folks at Startup Exemption and some others will be creating a “self-regulating” organization (SRO) to be the voice of the crowdfunding industry and work with the SEC to regulate funding platforms – much as FINRA does in the broader financial services industry.

Because of this, it is likely that the limits and regulations that we will see in the SEC and SRO rules will, in all likelihood, be very similar to those laid out in the CFI Framework.  The limits include provisions, such as:

  • an upper limit of $1 million in funds raised
  • only for USA “small businesses”, i.e., those with average annual gross revenue of less than $5 million for the last three years (or since incorporation if less than three years)
  • investments from unaccredited investors will be capped at $10,000 or 10% of their prior years Adjusted Gross Income (AGI)
  • all funding platforms will need to be “registered”
  • prior to using a crowdfunding platform, investors will have to agree that they understand:
    • there is no guarantee of return
    • they could lose their entire investment
    • their liquidity/return is limited to any dividends, sale, public offering or a merger of the company
  • the registration process for the business owner/entrepreneur will require significant personal information (to reduce the risk of fraudulent fund raisers)

With these kinds of limits and regulations (and others), it doesn’t look like the “wild west” that some opponents of the legislation have conjured up in their rhetoric.

On a different note, some of the legislation’s opponents also seem to think that “funding” is not really the issue that is holding back many small businesses, but I would beg to differ.  In a recent Wall Street Journal special section “Squaring Off on Small Business”, they had two people arguing the opposite sides of “Should Equity-Based Crowd Funding Be Legal?”.  “The Risks Are Too High” guy’s comments ran over onto the next page where, associated with another article, there was a survey that said entrepreneurs’ biggest challenge is “access to funding” – by 75% more than the next closest challenge.  Sort of blew his argument out of the water!!

In my experience, the large majority of angel and early stage funding today seems to be focused on technology opportunities – i.e., the next Facebook.  Meanwhile, I have seen good non-technology business ideas struggle to obtain the funding they need for the next step.

I’m pretty sure that the “crowds” will do just as good a job as “high-net worth individuals” of sniffing out good ideas – maybe they’ll even do a better job because every decision will not be controlled by the WIIFM (what’s in it for me!) that seems to underlie the decisions of the crowds chasing the next Facebook.

I, for one, am looking forward to equity-based crowd funding. What about you?

Excellent Execution

Equity Crowdfunding – Just Around the Corner

7 thoughts on “Equity Crowdfunding – Just Around the Corner

  • April 1, 2012 at 10:03 am
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    [This comment was originally posted to a LinkedIn Group]

    Hello John

    I have been following this JOBS debate with interest. What do you think?

    From my point of view. The smaller companies will be able to procure funding more easily and rapidly. Smaller loans to support companies who wish to employ. I have tried for years, to soften the aggression of the Securities Industry in my Country (But never knew its course were directed from the US). To generate investors or partners for small to medium companies has been near to impossible, unless you have $US100,000 to list. A steep price to pay if you only need like $US300,000 for example.

    This law seems to take step forward and my personal view is that it is good for the US, could be good for my Country too.

    Just as an informative link. My Country signed a protocol document with the US to concur bi-laterally with all Securities Control Issues, many years ago. So what happens there could happen here.

    Regards
    HS

    Your comments please.

    Reply
    • April 2, 2012 at 11:54 am
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      [This comment was originally posted to a LinkedIn Group]

      Heinrich,
      As I alluded to in the blog post, I think it will be good for start-ups – especially outside the “technology” space.

      I’m not PollyAnna enough to think that there will not be some companies who shouldn’t get funded, but who will raise money through this mechanism. I’m sure the opponents of the idea will jump on these cases to justify their position. However, it happens today within the current regulations, so it’s not a reason to not allow crowd-funding.

      Hopefully the funding platforms will allow some kind of crowd ranking of an opportunity – other than just how many people have contributed funds – acting as kind of a company analysis, much like you get from financial analysts on public companies.

      I also think it will allow the cream to rise to the top and get more easily noticed by angels and early stage venture firms – after all, as ‘accredited investors’ there is no limit to the amount of money you can accept from them.

      I’m going to closely follow the regulation-setting exercise.

      John H.

      Reply
  • April 2, 2012 at 11:56 am
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    [This comment was originally posted to a LinkedIn Group]

    John, I agree with your assessment that crowd funding will help small business and that the high worth individuals are blind to other good small business opportunities. You said the naysayers gave many arguments against crowdfunding. Can you share some of the arguments they made?

    Reply
    • April 2, 2012 at 4:22 pm
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      [This comment was originally posted to a LinkedIn Group]

      Dr. Phil,
      The ‘naysayers’ side of the discussion in the WSJ article “Should Equity-Based Crowd Funding Be Legal?” was titled “No: The Risks Are Too High” by Dr. John Torrens, a “professor of entrepreneurial practice at Syracuse University”.

      From an investors standpoint, he stated that the lack of audited financials (flawed numbers, hidden liabilities) and that the investments would be in illiquid instruments would hurt “average citizens” when compared to buying traditional stocks.

      From the entrepreneurs’ perspective he said that “equity-based crowd funding would rob small companies of access to everything that traditionally comes with capital”, such as industry experience, market intelligence and a valuable contact list. He thinks entrepreneurs are better off raising money from angels (obviously he hasn’t tried to do that recently).

      In addition to not bringing any other value, Dr. Torrens said that the “crowd … could bring a whole host of new problems that were never contemplated”; going on to cite “managing investor relations and communications with a large number of potentially unsophisticated investors” as something that will take time away from running the business.

      He also says “not to mention the potential legal and tax ramifications that will need to be addressed”. As he didn’t make any further mention of these I don’t really know what he was alluding to.

      He states that “many of these companies are not good candidates for equity capital – either from angel investors or crowds”. He tries to justify this statement by saying that “if angel investors have passed them by, there is probably a good reason”. Of course he doesn’t acknowledge the total scarcity of angel funding outside of the technology space.

      He suggests that these “not good candidates” should use one of the non-equity based crowd funding sites, or that we should create a vehicle where the crowd would fund a debt-based funding pool.

      None of which I found very convincing.

      John H.

      Reply
      • April 2, 2012 at 4:49 pm
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        [This comment was originally posted to a LinkedIn Group]

        John, Thanks for sharing! I agree with your assessment of the reasons given. Wealthy investors and big business are making a concerted effort to crowd out entrepreneurs because they want everything to themselves. The attitude is one of command and control and that is the last thing we need in a recovery. We need new leadership to show the way and fill the gaps not being filled by big business and the wealthy. Problems are not something entrepreneurs cannot solve. I believe wealthy investors and big business is no less risk averse than anyone else and I hope the passage of this bill will help level the playing field. Free trade should include “fair trade” and I see the passage of this bill as a step in the right direction.

        Reply
  • April 2, 2012 at 12:36 pm
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    [This comment was originally posted to a LinkedIn Group]

    Great article John – Here is the “thing” you and I need to help get across to the public. The money will now be there…. Are you (the CrowdCo) willing to use it properly and gain the other resources you need to be a great product or company?

    Nothing provided in the legislation helps guide the use of the funds and this will be where challenges will occur. As the plethora of CrowdFunding sites pop up I hope companies and services like yours get full attention to help support America’s new ventures.

    Hey John – join us at http://www.meetup.com/North-Texas-Crowdfund-Roundup/ – we could use your insight

    Reply
  • April 2, 2012 at 2:19 pm
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    [This comment was originally posted to a LinkedIn Group]

    I love crowd-funding and have used it for a client. In Canada we do not have as many sites as the US does but it is a great boon to small business! I find it the most useful for start ups that need less than $100,000 but i think that as time goes on that number will rise. My friend’s daughter used it to raise enough money for her band to be able to produce an album for which she needed $10k, she got the money within a month from strangers paying $2 to $50 at a time. How amazing is that!

    Reply

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