The SEC’s crowdfunding rules (under Regulation Crowdfunding) became effective earlier this week. From the legal and legislative perspectives this was a big day since it marked the effective date of
one of the most heavily anticipated and promoted components of the JOBS Act. It is also the last provision of the JOBS Act to be put into practice. Reward-based crowdfunding has been operational for a long time and has had some pretty positive results, but the SEC’s equity crowdfunding rules were going to be a way for small investors to make equity investments in small companies and help foster the growth of the tech and innovation economies.
Unfortunately, as reported in my prior blog post and just about everywhere else, the execution of the final crowdfunding rules has resulted in a system that is probably not viable for most situations. While the new rules may work in some cases, they create barriers that I believe will prevent widespread use of equity crowdfunding as a financing vehicle. One of the best summaries of Regulation Crowdfunding problems and deficiencies can be found in this post which quotes Jeff Lynn, the CEO of Seedrs (a prominent crowdfunding platform). He is certainly a guy who believes in the crowdfunding concept, but he says that the crowdfunding regulations in their current form are not workable. Lynn also advises US regulatory authorities to study the UK crowdfunding model, which he believes allows companies to raise funds while still providing investor protection.
The main problems with the new crowdfunding regulations are practical ones. First, the funding limit of $1 million each year is just too low for most companies. This is similar to the problem that we saw with Regulation A for a long time – essentially no one used it because the limit was too low in relation to the costs (although the old Regulation A limit was $5 million, substantially higher than the current crowdfunding limit). Regulation A+ has fixed this problem for Regulation A offerings, but the low limit remains a huge challenge for crowdfunding offerings. This low limit problem is made worse by the costs associated with a crowdfunding offering, which will be substantial for a small company. Legal and accounting work will be required. Companies must also use a registered funding portal in connection with the offering, and this will add to the cost burden. Finally, companies cannot “test the waters” before beginning an offering to see if the offering is even viable for them. The combination of all of these factors creates significant practical roadblocks for crowdfunding that cannot be overcome without some adjustments (as discussed below).
I don’t want to seem negative here. I am a huge supporter of practical methods that will help small companies raise money to get out of the gate. In my job I often encounter promising small companies who stumble and even fail over lack of money, and these are very negative situations. I have no objection to Regulation Crowdfunding and I heartily support its aims, but I just don’t think that it’s going to be a viable option for most companies.
There has been some good movement to try to fix these crowdfunding problems and to try to create a more useful crowdfunding structure. Representative McHenry (R, North Carolina) has introduced a Bill in the House of Representatives that would create the aptly titled “Fix Crowdfunding Act”. The text of this Bill (HR4855) can be found here. As summarized in this article, this Act would fix many of the problems that exist with the current crowdfunding regulations. This proposed Act calls for a $5 million annual funding limit (still low, but much better, especially for small companies). It would also allow an issuer to “test the waters” to determine the viability of an offering before getting too far along in the process. This is a critical fix because issuers could evaluate the chance of the success of an offering before having to spend too much money. Finally, the Act would allow the use of Special Purpose Vehicles in a crowdfunding offering. These are business entities which are designed to pool investment funds from a number of investors into one investment entity. It is too early to gauge the chances of success for the Fix Crowdfunding Act, but hopefully it will result in some meaningful changes that increase the viability of equity crowdfunding as a financing method. We will continue to monitor the progress of this proposed Act as it makes its way through Congress and will keep you updated.