Paving the Way for Crowdfunding

Posted by: John Tozzi on November 3, 2011

The federal government is moving swiftly (by government standards) to make it easier for small businesses to raise capital in ways that haven’t been possible before.

Less than two months since the White House included the idea in its jobs package, the House is voting on bills this week to lift restrictions on crowdfunding and increase the amount of money companies can raise before having to register with the SEC. These proposals have the backing of House Republicans and the Obama Administration, camps that don’t agree on much legislation these days.

Securities laws designed to protect investors limit how much money businesses can raise, who they can raise it from, and how they can raise it, without going through the costly and cumbersome process of registering a public offering with the Securities and Exchange Commission. Those laws are part of the reason that businesses raising money on crowdfunding sites such as Kickstarter can’t sell equity.

The House bill H.R. 2930, backed by North Carolina Republican Rep. Patrick McHenry, would exempt companies raising up to $1 million (or $2 million for those providing audited financials), from SEC registration. No individual investor could put up more than $10,000 or 10 percent of annual income, whichever is less, to limit the amount they can put at risk. Those investors will not count toward the 500-shareholder cap (once private companies have more than 500 shareholders, they have to register with the SEC). Other legislation would remove the ban on advertising small offerings.

The bill would also pre-empt state securities regulators to make it easier to raise capital from investors in many different states, a provision that state regulators objected to. They say it will open the door to fraud.

The goal here is to make securities laws written in the 1930s more flexible for businesses that want to raise smaller amounts of money. There are a lot of unanswered questions, some of them highlighted in a new Bloomberg Government report on the proposal by Afzal Bari:

  • Would such a change create jobs? There’s little evidence either way.
  • What information will crowdfunding investors get? How much disclosure and transparency would be required?
  • How will minority shareholders rights be protected?
  • How will crowdfunding investors sell their shares? Will there be a secondary market?

How to price the offerings of illiquid stock for small businesses and startups (which are inherently difficult to value) is a whole other question. I’d also ask whether such a change opens the door for fraudsters, and whether regulators are adequately equipped to police them.

Reader Comments

Guillaume

November 4, 2011 8:41 AM

The legal issues are similar in Europe. We are working hard on it too to allow startup to crowdfund their investment needs. http://www.mymicroinvest.com will offers startup equity to crowdfunders from February 2012. See you there!

Scott Supak

November 6, 2011 11:46 AM

I'm wondering if Kickstarter will be able to accommodate this exciting development.

As for the regulatory problems, how hard could it really be? The problem with regulatory agencies is more about who is appointed to run them (chickens guarding the hen house) than actual logistical problems, which could easily be met with the right people, funding, and technology.

Connor Doherty

November 8, 2011 9:20 AM

We've been following these developments quite closely, and can only welcome them.

Entrepreneurs have long been the back bone to the American economy, and things that can make it easier for startups to blossom is good in our book.

At Seedups we've been working on a solution for tech-startups seeking seed capital via crowdfunding, so we're interested to see how it works in both the USA and Europe. For more information, visit http://www.seedups.com

Connor

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About

What's it like to run your own company today? Entrepreneurs face multiple hurdles new and old, from raising capital and managing employees to keeping up with technology and competing in a global marketplace. In this blog, the Small Business channel's John Tozzi and Nick Leiber discuss the news, trends, and ideas that matter to small business owners. Follow them on Twitter @newentrepreneur.

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