What are the potentially sticky regulatory issues for the various interest groups: investors, issuers and intermediaries?
The biggest issue for issuers is how much will audits cost at the different thresholds. This is a big unknown and can easily increase the cost of capital. For issuers it is will self certification on one’s income or net worth be sufficient or will further disclosures be requires which will increase bureaucracy and reduce the interest of potential investors, particularly at the sub $500 investment range. For intermediaries can organic data be used to drive results? eg: if a pitch is going viral can this show up on the front page as “hot campaigns” or will only broker/dealers be allowed to show this?
The JOBS Act, Title III is a large body of work that once unraveled requires thoughtfulness to all constituents in the ecosystem, Intermediaries (broker dealers/ funding portals), issuers, investors, third party providers, and so forth. The rules have to be developed in a such a way that will allow for implementation, growth, and sustainability while ensuring investor protection remains at the forefront of the industry.
When it comes to investors, it still isn’t clear if accredited investors will be subject to the same limitations and regulations as non-accredited investors for crowdfunding offerings. This could be a disincentive for accredited investors to participate if they will be required to follow the same rules.
As far as portals go, sticky regulatory issues include the distinction between investment education and advising. Portals have to be very careful to offer as much investor education as possible without triggering investment advisor regulations. As it stands, portals are not permitted to give investment advice; however, they are required to provide investor education. What’s the difference? I have no idea. It’s a very fine line to walk.
There are two important issues that issuers and entrepreneurs face. First, the issuer is going to have to get comfortable with disclosing a large amount of information to the general public including their business plan, their financials and criminal background. Most entrepreneurs hold their “secret sauce” very close to them and they won’t feel comfortable sharing that information – they won’t have that luxury with crowdfunding.
Secondly, entrepreneurs have to know up front whether they want to raise money from friends and family, accredited investors or the crowd. Due to the fact that each of these three offerings falls under different exemptions to security regulations, they will not be able to mix and match. So, taking these two issues together, if an entrepreneur is not comfortable sharing detailed information about their self and business, and they believe they will be able to raise money through friends and family and accredited investors combined, crowdfunding may not be the best choice for them. Along those same lines, should an issuer have a compelling idea, but no built in network of friends and family or strong relationships with very high net worth individuals, crowdfunding may be a very attractive alternative.
Sherwood Neiss and his business partner Jason Best led the U.S. fight to legalize debt and equity based crowdfunding, co-authored Crowdfund Investing for Dummies and founded Crowdfund Capital Advisors where they provide strategy and technology services those seeking to benefit from crowdfund investing.
Kim Wales is the Founder of Wales Capital and Crowd Bureau and a Board member and Founding member of the two leading Crowdfunding trade organizations, the Crowdfunding Professional Association (CfPA) and the Crowdfunding Intermediary Regulatory Advocates (CFIRA).
Candace Klein is the founder and CEO of two successful startup companies: Bad Girl Ventures and SoMoLend. SoMoLend is a new technology platform that connects business borrowers seeking loans with lenders looking to make a return on investment.
When might we expect to see final rules?
We should expect to see final rules around July/August 2013
This is twofold, since the industry is awaiting Title II rules to be issued since October 5, 2012 – which lifts the ban on general solicitation and advertising, this will mostly happen first quarter 2013. Title III which is Crowdfunding, the S.E.C. was scheduled to issue rules within 270 days of the signing, placing the completion date at December 31, 2012. Since that date has been missed, the industry is awaiting the next steps and/ or the issuance of a new target date for the rules to be issued to the public. The best outcome would be a healthy body of rules that are not over burdensome, low to no cost to implement for the funding portals, yet where additional disclosures and safe harbors rules are needed to protect issuers and investors that they are put in place so that the industry can foster a vibrant marketplace.
We believe that the staff has completed their draft rules. Now that Chairman Walter is leading the SEC, it’s quite possible the rules will be put forward for public comment by 1st quarter 2013. If that occurs, we could see crowdfunding fully implemented by this fall.
Elizabeth Smith Kulik:
While everyone had been hoping for the original 270 day deadline of January 2013 to work, it is clear that a number of issues both general SEC administrative business and with the regulatory proposal, itself, will force a much later date for the SEC to issue final rules and FINRA to implement. Best guess now is somewhere between Q3 2013 and Q1 2014. Here’s the math.
New SEC Chair (+ 3 months) Jan-March
The departure of SEC Chair Mary Schapiro will potentially force yet another several months into the process. After all, President Obama has a few other priorities like the fiscal and debt cliff on his mind to contend with!. Say nomination and ratification happens by end of February. Then the new Chair will take at least 30 days to acclimate to the SEC role in general.
Revised Proposal (+1 month) April
Let’s say the new SEC Chair is truly a wizard, and a new proposal is submitted within 60 days of the change in administration. This adds another month to the process.
Public Comment (+90 days) May, June, July
There is a 90 public comment period that follows the release of the SEC’s final proposal. By now the calendar is reading July/August.
SEC Response (+1 to 2 months) August, September
Following the required 90 day public comment period, the SEC must summarize and integrate suggestions internally to SEC stakeholders.
Schedule Final Rules Vote (+2 weeks to 1 month) October
Once the comments have been integrated a vote will be scheduled. On the assumption that everything proposed will get a green light, the SEC will issue its rulings on equity-based crowdfunding.
However, this is not the final step in actually releasing the crowd to fund new businesses.
Governance (+1-4 months)
The next and truly important step in opening the floodgates for legal equity crowdfunding is the establishment of the required governing organization responsible for governing intermediaries, the crowdfunding portals and broker/dealers. That body, most likely FINRA, will need to further examine the SEC rulings in order to establish their own practical approach to implementing governance.
All hopes are that will be a quick process. However, this is up for discussion and speculation.
Approving Crowdfunding Portals & Broker/Dealers
Once the SEC regulations and FINRA governance is complete, crowdfunding sites, themselves will have to be approved for operation.
It is easy to see how crowdfunding equity will not reach the market until late 2013 to early 2014. We all hope for better, but will realistically prepare for a late start.
Elizabeth Smith Kulik is Co-Chair of the CfPA Education Committee and Co-Founder of ProHatch. ProHatch is the Crowdfunding Incubator where Projects Hatch & Grow.
How will all of this manifest in marketplace?
Hopefully, the implementation of Title II and III will be approached carefully and methodically yet aggressively by the industry realizing that education is a requirement for the marketplace since under Title III we are targeting the unaccredited investor and small and emerging companies that may not have a comprehensive knowledge of the capital markets.
Will the delay scare off a wave of potential issuers and intermediaries?
It won’t scare off issuers as much as frustrate them that the SEC isn’t listening to the will of the people. Delays for Intermediaries mean that they might run out of capital before the industry kicks off.
No. The delay is simply providing an opportunity for more intermediaries to come on the scene and issuers can already use some platforms right now, such as via SoMoLend.
Elizabeth Smith Kulik:
In the short term, yes, but in the longer term, the delays will be beneficial, and issuers, investors and intermediaries will see the promise of crowdfunding. Let’s face it, businesses are always in need of capital, especially in economic cycles like this where traditional capital is scarce. As soon as the rules and regs for crowdfunding are well clarified, the market will begin to embrace crowdfunding as a viable alternative source of capital formation.
Will the advent of crowdfunding free up capital from more traditional routes — i.e. banks and VC firms?
It will de-risk follow on capital from more traditional routes. Banks and VCs can now tell people they otherwise would have said no to, “go see if you can crowdfund the first $100k from 100 investors. If you do, come back and let’s talk.”
Yes, one of the things we are doing at SoMoLend is offering banks a leveraged loan product. So for those businesses that may have been considered borderline and ineligible for bank funding in the past, they can now raise a portion of their requests from the crowd. This helps businesses prove that there’s demand and liquidity through crowdfunding, building credibility and ultimately making them more attractive to banks, angels and other traditional finance options.
Elizabeth Smith Kulik:
Crowdfunding will be an unlimited pipeline source of deals for banks and more traditional VC firms. Already, VCs are becoming educated on crowdfunding and will find their way to investing as accredited sponsors.
Will crowdfunding prevail regardless of what the final rules are or can an overly aggressive stance by the SEC essentially snuff out the market?
Crowdfunding can only prevail if the SEC lets it. They control the market for buying and selling of securities.
I’m of the belief that since Congress overwhelmingly approved and it’s supported by the President, it will prevail. Also, through meetings that I’ve personally had with the SEC, I firmly believe they are not opposed to CF and will not be taking an opposing stance.
Elizabeth Smith Kulik:
The SEC has the power to squelch the market by applying institutional standards to crowdfunding. It is important to remember that the essence of the JOBS Act is to allow smaller and new businesses to access capital in a way that is much more cost effective and simple than traditional methods of capitalization. Without this in the forefront, crowdfunding equity will be difficult in the US, but not unachievable.
Are there any elephants in the room on this issue — any major points/market dynamics that people just don’t see at the moment?
The world is sitting idly waiting for the SEC to act. Countries globally that follow US Security regulations see the benefit for the economies by enacting this legislation. They can’t move forward until the SEC finishes its job.
Elizabeth Smith Kulik:
Valuation and future success of any business are issues that will need to be addressed in the near future. Crowdfunding certainly adds a new dimension to capital formation, but does not obviate the core problems of determining a valuation that fairly prices equity, nor that the early stage business will succeed. In many ways, this is the most important aspect of crowdfunding, because crowdfunding is simply another source of capital. Valuing and operating a business is the next most difficult challenge of any early stage business.
Do I have any Intellectual Property (IP) and why do I care when I am crowdfunding?
Crowdfunding means that your ideas are put online and you absolutely need to identify and decide how to protect the Intellectual Property associated with your business ideas.
“White Paper on Intellectual Property Protection”
Also, here is a link to an eFactor IP and crowdfunding webinar – http://www.efactor.com/topcrowd3
Mary Juetten is a CfPA Member and on the Education committee. Mary Juetten is a recovering accountant and a law school graduate with over 25 years experience in finance and business. Ms. Juetten founded Traklight in 2010, a website with online IP identification and protection tools for startups, inventors, creators, and small businesses.
How Are Securities Offerings Regulated by the SEC?
White paper on Securities Compliance and exemptions to the Securities Act of 1933 Registration Requirements (including Reg D and the coveted Crowdfunding Exemption)
Nav Athwal is a member of CfPA and a Founder of www.realtyshares.com, a Real Estate crowdfunding platform. Nav is also a Real Estate and Securities Attorney, real estate broker and investor. Nav graduated from UC Berkeley School of Law in 2010 as the class Valedictorian.
What is Crowdfunding?
Crowdfunding is the act of many people (the crowd) contributing money to an individual or business so that individual or business can complete a task. The recipient may be a charitable organization, artist, filmmaker, product designer or small business. The task may be a creative project, the creation of a new business or the funding of a cause among other things.
Charles Luzar is a member of the CfPA’s PR Committee, the CF50 and CFIRA. He is Director at Crowdfund Insider, a media organization dedicated to covering the worldwide crowdfunding movement.
How many kinds of crowdfunding are there?
There are two main types of crowdfunding: donation crowdfunding and investment crowdfunding.
Donation crowdfunding is the type of crowdfunding that happens on platforms like Kickstarter, Crowdrise, Indiegogo and others. Money is donated to a cause, individual or company. Sometimes this donation is given with the understanding that the donator will receive something in return like a t-shirt, mention in a film’s credits or even a new product. This is often called “rewards crowdfunding,” but the returned good is not legally guaranteed. If the project fails the contributor may not receive their rewards.
Investment crowdfunding takes place on SEC-registered platforms (called “portals”) and is comprised of two types: lending and equity crowdfunding. Lending crowdfunding is when an individual or business agrees to take on debt in the form of money from the crowd. That debt is paid back to the crowd over time at a predetermined interest rate. Equity crowdfunding is when a business offers equity in the business to the crowd at a predetermined valuation.
What is the JOBS Act?
The JOBS Act was signed into law on April 5th, 2012 after getting through congress with bipartisan support. The law has two sections that pertain specifically to crowdfunding.
Title II of the JOBS Act legalizes general solicitation to accredited investors. This means that crowdfunded securities and the entrepreneurs that create them will be permitted to advertise directly to sophisticated investors that meet the minimum standards required to be an accredited investor in the United States. Title III of the JOBS Act legalizes investment crowdfunding for non-accredited investors. This means that any US citizen will be allowed to invest in companies directly and receive a stake in the company in return.
What crowdfunding website is right for me?
There are hundreds of crowdfunding web sites out there, and choosing the right one can be hard. Here are things to consider when selecting a web site:
- What type of campaign are you running? Different web sites deal with different types of campaigns. Do you want donations? Are you going to be selling equity? Would you like a loan that you plan on paying back? Reference the types of crowdfunding and choose one.
- Consider your network. If you already have an existing network and you are confident in your ability to raise funds regardless of the platform, a platform with lower fees may be the best choice. If your network is lacking, you may want to consider a platform that garners more.
- Consider your niche. What crowdfunding sites are visited by the people that are most likely to contribute to your campaign? Certain crowdfunding platforms specialize in niches like health tech, charitable causes, video games, social enterprise and more. These platforms may have already captured the attention of your target audience.
- What value adds does the platform provide? Some platforms offer value added services like mentoring, around the clock support, marketing support and more. Consider what the platform does for you other than listing your offering.
- Consider past campaign success. When evaluating a platform, look at their past campaigns. How many campaigns have been successful on the platform? This is often a good indicator of how effective the platform is for the entrepreneurs that use it.
I want to launch a crowdfunding campaign. Where do I start?
There are some basic guidelines people can follow to increase their likelihood of a successful crowdfunding raise. We have provided a comprehensive how-to guide here for those who are new to crowdfunding.