In Silicon Valley, it’s almost dogma that you start with a minimum viable product and iterate—the techie version of throwing spaghetti against the wall and seeing what sticks. So why shouldn’t it be the same with investment crowdfunding?
As we prepare for the long awaited roll out next month of Title III, the final and most radical piece of the JOBS Act, that question is worth keeping in mind. Because, despite all the years of planning and deliberating that went into the JOBS Act, it’s still very much a work in progress.
That much was clear at a recent hearing of the House Financial Services Committee entitled “The JOBS Act at Four: Examining Its Impact and Proposals to Further Enhance Capital Formation.”
While lauding the progress of the landmark legislation to date, the hearing provided an opportunity to explore new proposals aimed at fixing some of Title III’s more glaring flaws and float additional ideas to help small businesses raise capital.
It’s not just at the federal level: more nimble states are already experimenting with their own variations on the JOBS Act that could someday filter up to federal laws—or vice versa. And every new state to join the club learns from the ones that went before it.
Illinois, for example, lets platforms take equity as payment from issuers in lieu of a cash fee. It also allows them to charge a success fee—something the SEC green-lighted for funding portals in the final Title III rules. “The Title III rules opened up the door for that” says Anthony Zeoli, a lawyer and intrastate crowdfunding advocate in Chicago.
The S.E.C. has been mulling improvements to make Rule 147, the federal exemption behind most state-based crowdfunding laws, more useful, too. A final ruling could come by this summer (or not!).
Here’s a look at two of the main proposals to improve crowdfunding at the federal level and further encourage small business capital formation.
Fix Crowdfunding Act (HR 4855)
Introduced by Patrick McHenry (R-NC), the original champion of the JOBS Act, the Fix Crowdfunding Act would do just what its name signals. The bill focuses on common sense fixes to the elements of Title III that have given many entrepreneurs, portals and potential investors pause. It would raise the amount that companies can raise from the current $1 million to $5 million, and slightly raise the amount that investors may invest.
The bill would also clarify terms for funding portals and bring Title III more in line with the rules of other JOBS Act exemptions including Title IV (Reg A) and Title II (Reg D rule 506 (c))
For example, under the final JOBS Acts rules, funding portals face legal liability if issuers listed on their platforms provide inaccurate material information or omit it altogether. And the exact circumstances that would trigger liability are open to interpretation. That’s made some crowdfunding players hesitant to embrace Title III.
Another big sticking point has been the barring of special purpose vehicles (SPVs) under Title III. The bill would eliminate the prohibition, allowing investors to be grouped into a single purpose fund that would count all the investors in the offering as one.
The fund approach relieves the issuer from having to manage hundreds or even thousands of individual investors. And, by simplifying the “cap table” (a company’s equity ownership structure), it makes the company more attractive to follow-on investors such as angels and venture capitalists. That would open the door for syndicates such as on Angel List, where smaller investors could invest alongside established angel investors.
Finally, it would also allow companies to “test the waters” before they commit to a crowdfunding raise and all the time and expense that comes with it. Companies can do that under Regulation A, and the ability to gauge investor interest has proven to be a very valuable tool. In addition to the obvious benefits to issuers, it also helps them avoid running afoul of the S.E.C., which under current Title III rules has a strict ban on pre-offering advertising or solicitation.
The amendments would go a long way in leveling the playing field for Title III, which many say is handicapped by its limitations before it even goes live.
“Expanding investment levels for Title III crowdfunding and limiting liability risks to funding portals mean reduced costs, expanded opportunities for both entrepreneurs and investors, more innovation in the marketplace, and greater choice for small business,” said Raymond Keating, chief economist at the Small Business & Entrepreneurial Council, in his testimony at the hearing.
Micro Offering Safe Harbor Act (HR 4850)
Also discussed at the recent hearing, the Micro Offering Safe Harbor Act is a new bill that would crate a new exemption from federal registration for certain offerings, and bring clarity to the kinds of informal friends & family deals that happen all the time. The bill defines micro-offerings as those raising less than $500,000 where the investors number less than 35 and have a pre-existing relationship with the issuer.
Such offerings may overlap with those currently being conducted under intrastate exemptions that have been enacted by 30 states. Those laws allow companies based within a state to raise money from investors of the same state, and are exempt from registration with the SEC but not the state. The Micro Offering, in contrast, would exempt companies from state “blue sky” regulation.
“I expect that this bill will generate a number of friendly and not so friendly amendments before it is voted out of the House Financial Services Committee,” wrote Sam Guzik in CrowdfundInsider. “Hopefully what emerges will be a useful, and long overdue, solution for capital raising for our country’s smallest of job creators.”
Before they can become law, both bills have to make it through the Senate as well as the House—in an election year, to boot. So while crowdfunding rules will surely evolve, we’re likely to have Version 1 for a while. Let’s give it a try and see what sticks.