Few issues in Washington get prodigious bipartisan support, but the 2012 JOBS Act’s equity crowdfunding title was one. After a long delay, Reg CF finally went live in last May.
But a year on some are asking, ‘Where is the Crowd?’ The crowdfunding total is approaching $40 million but it should be billions. A recalcitrant SEC and onerous regulations are two possible answers to why equity crowdfunding has experienced steady but unspectacular growth in year one.
To solve this, the House passed the Financial CHOICE Act. Although mostly a remedy to Dodd Frank, the Act includes a complete overhaul of equity crowdfunding. In fact, it includes a complete deregulation. According to CrowdfundInsider.com:
- gone are limits on how much a company can raise;
- gone are requirements for financial statements or, for that matter, any other type of disclosure;
- gone are requirements to file annual reports after completing a raise;
- gone is the risk of inadvertently becoming a fully reporting company, as purchasers of these securities are not counted towards the 500 non-accredited shareholder limit;
- gone is the requirement to conduct the offering on an SEC and FINRA registered portal;
- gone are restrictions on “off portal” solicitation and advertising; and
- gone are the restrictions on how much an investor can invest.
The chances of complete deregulation are slim. First, the bill has yet to face the Senate where some or all of it could be tossed in reconciliation. Second, the SEC must implement what survives. Some have accused the agency as being openly hostile to the very idea of crowdfunding. As Edward Knight, Executive Vice President and General Counsel of NASDAQ, stated in a March JOBS Act hearing for the House Committee on Financial Services:
From the outset the SEC’s view of [equity crowdfunding] was they were not for this they and made it shall I say needlessly complicated and did not approach it except as this this was something where the public is going to get harmed and we need to narrow it as much as possible.
At the very least, the SEC doesn’t seem to react well to change. Acting SEC Chairman Michael Piwowar described the changes the JOBS Act makes to the SEC’s mission this way:
The JOBS Act requires the Commission to think of capital formation and investor protection in fundamentally different ways than we have in the past. The crowdfunding provision of the JOBS Act forces us to think outside of our historical securities regulation box and to create a different paradigm than the one we have used for the past eight decades.
Whether through the CHOICE Act or a standalone bill, equity crowdfunding needs changes to reach its potential to provide much needed capital to America’s entrepreneurs and small businesses. The sooner Congress enacts these reforms the faster America’s economic engine can start humming again.
By Jossey PLLC
Equity crowdfunding celebrated its first birthday last week. The innovative securities law democratizes business capitalization and allows anyone to potentially make a bundle on a young company. Although Congress must tweak the law to realize its potential the future looks bright.
The naysayers fretted equity crowdfunding wouldn’t work. They said scandal and fraud would taint the process. Thus far they are wrong; the system of checks and balances between accountants and lawyers representing companies and due diligence by funding portals has combined to root out fraud while educating investors about the risks.
According to Catherine Yushina, COO & Co-Founder of Startwise, so far 265 companies have entered the equity crowdfunding market aggregating an impressive $37 million in investment. Around half have successfully completed a fundraising round.
But this is just the beginning. There are approximately 100 million startups opening each year and only 798 venture capital funds in the U.S. And of existing small businesses, 80% have never considered alternative funding options. That is changing rapidly. In the next few years the alternative funding market will grow to 20% of small business capitalization.
Early adopters represent a wide-range of industries including tech, real estate, fashion, sports, and entertainment. Food & Beverage and Wine & Spirits lead taking a combined almost $11 million.
But it’s not just about the boon to new businesses needing capital. On the giving end, millions of people now have the opportunity to invest in newest companies at a fraction of previous amounts. Before Title III of the JOBS Act the SEC only allowed “accredited investors” to participate in crowdfunding. This represented about 8 million people. Now around 240 million people can invest in potentially lucrative ventures at their beginning stages.
More exciting is that confidence is growing in the new markets. According to We-Funder, the average early investment was under $250, by the end 2016 it had jumped to $833 per person.
Seeing the success rewards based crowdfunding platforms have started offering securities. Crowdfunding platform giant Indiegogo is an impressive 12 for 12 in successful startup funding.
The future looks bright but Congress still has a role. When the SEC finalized the rules, it determined limits from the statute. Instead of taking the higher of annual income and net worth as the operative number to base the limit it went with the lower.
This can be big a difference. For instance under this approach, an investor with annual income of $50,000 a year and $105,000 in net worth would be subject to an investment limit of $2,500, in contrast to the proposed rules in which that same investor would have been eligible for an investment limit of $10,500. Using this lower limit hampers a startup’s most fervent supporters from pushing a potential issue over the top. Moreover, the overall limit of a little over $1 million per year is too low for many crowdfunded projects and harms market fluidity and dynamism. Another current proposal calls for tax credits for equity crowdfund investors.
While Congress hashes out improvements, the future of equity crowdfunding is bright. Given the number small businesses and startups in the US and the number of potential investors analysts could be discussing future birthdays in terms of billions, not millions.
By Jossey PLLC
Equity crowdfunding’s first six months ended in December, the numbers are in and the outlook is promising. So far, the crowd has given entrepreneurs and business startups millions in funding, filling a crucial market gap. As the kinks are worked out crowdfunding will continue to expand and become a viable option for thousands more new and growing American businesses. But in just a half year the industry’s dynamism is already apparent.
Crowdfunding in all forms topped venture capital in 2016. The crowdfunding industry is doubling or more every year. As stated in a recent article, equity crowdfunding alone will surpass venture capital as the leading source of startup money by 2020 if it stays on the same trajectory.
During the first six months businesses could take advantage of equity crowdfunding, 187 issuers made offerings, 24 were pulled leaving 163 asking for a total of $18 million. As of January 15, 33 offerings with year-end deadlines had closed receiving $10 million. Each month in 2016 brought an average of 22 new offerings over a variety of industries and through multiple portals.
According to the SEC, the average offering was targeting $110,000; the average scale of new offering activity on a monthly basis was approximately $2.4 million. Among those that reported non-zero total assets or sales in the prior fiscal year, the median asset growth was 15% and median sales growth 80% for the most recent fiscal year.
Early adopters were mostly small companies needing quick infusions of cash. About 40% of issuers reported non-zero revenue and 9% of issuers reported a net profit in the most recent fiscal year. Among issuers that reported non-zero assets in the prior fiscal year, the median growth rate was 15%. Thus crowdfunding is providing funds to new businesses that current markets weren’t servicing: startups and young businesses with relatively modest financial needs and lacking the sophistication or need for bigger offerings. Most issuers, 36%, opted for common or preferred equity. Debt accounted for 20%, and there were various other security types, such as units, convertibles, “simple agreements for future equity,” and others (including revenue sharing and membership / limited liability company (LLC) interests).
So what is exactly is equity crowdfunding?
It is part of the Jumpstart of Our Business Startups (JOBS) Act. Congress enacted this law on April 5, 2012. Title III of the JOBS Act amended Section 4 of the Securities Act of 1933 (Securities Act) and created a new exemption from registration for Internet-based securities offerings of up to $1 million over a 12- month period.
Here are the basics:
- A given issuer is able to raise up to $1 million across all crowdfunding offerings in a 12- month period. An issuer must raise at least the target amount to receive funds. Crowdfunding securities are generally subject to resale limitations for one year.
- The rules imposed limits on the amount that an investor can invest in all Title III crowdfunding offerings over a 12-month period. Investors with both an annual income and net worth of at least $100,000 can invest up to 10% of the lesser of annual income or net worth, but an investor’s total investment across all Title III offerings may not exceed $100,000 in a 12-month period. Other investors can invest the greater of $2,000 and 5% of the lesser of annual income or net worth;
- Crowdfunding issuers are subject to disclosure requirements at the time of the offering (on Form C), during the offering’s progress and on completion of the offering (on Form C-U) and annually in the form of annual reporting requirements (on Form C-AR).
- Issuers in larger offerings face additional financial statement requirements – in offerings of over $100,000 in a 12-month period, financial statements must be reviewed by an independent accountant, and in offerings of over $500,000 in a 12-month period (except the issuer’s first offering), financial statements must be audited.
- Crowdfunding securities must be offered through a registered broker-dealer or a registered funding portal, a new intermediary type established by the 2015 rules. These intermediaries are mandated to take measures to reduce the risk of fraud, make required disclosures about issuers available to the public, provide communication channels to permit discussion of offerings on the platform, disclose the compensation received by an intermediary, provide educational materials to investors, and comply with additional requirements related to investor commitments, notices to investors, and maintenance and transmission of funds. Registered funding portals that participate in crowdfunding offerings may engage in a narrower set of activities than broker-dealers.
According to the SEC, As of December 31, 2016, 13 funding portals have facilitated equity crowdfunding offerings. FINRA has approved an additional 8 portals and many more will arrive in 2017. The five largest portals based on the number of offerings accounted for 71% of initiated offerings. Hence, the majority of offering activity is limited to only a quarter of the active intermediaries in the crowdfunding market. The results are more skewed towards the five largest intermediaries when considering only completed offerings; they accounted for more than 90% of market share.
The future of equity crowdfunding is bright but could be even brighter. Some Congressional fixes could make it explode. In the next post, I will discuss how Congress could help even more entrepreneurs and small businesses with some fixes.
By Jossey PLLC