How The JOBS Act Gets it Wrong—And DPOs Get it Right

John Katovich | March 18, 2016


The last few years have been exciting ones, as new crowdfunding laws at the state and federal level have been passed that allow people to easily invest in small, growing companies—the kind of investments that, since the Securities Act of 1933, have been the exclusive purview of accredited, or wealthy, investors. In many ways, it seems a return to the way investing was done for millennia, by people backing entrepreneurs that they know and trust, and who are often creating enterprises that will benefit their communities.

It makes for nice nostalgia. But the truth is, many of the new rules are going in the exact opposite direction of how investing has historically been done, and those rules have created more barriers, not fewer, in terms of getting to know who you might invest in.

Many of the new crowdfunding laws are not designed to nurture personal connections between investors and entrepreneurs; rather, they prohibit investment conversations with company insiders.

For example, under the Title III of the JOBS Act (and the crowdfunding exemptions of many states), companies must post their offerings on a third-party “intermediary” platform, and cannot conduct the offering themselves. This limits what a company can say directly to its potential investors, and what potential investors can learn by engaging directly with those running the company. In essence, a new barrier has been placed between the issuer and a potential investor, creating a higher chance that the investment will be a speculative one.

Personal Connection

Investing has almost always been more about personal interaction than any reaction to, or singular reliance on, data. Consider how companies raise funds privately or even publicly through an IPO (initial public offering). In each and every case, the company or its representatives sell those offerings, and the investors will typically only buy (invest) if they can get to know the team.

Angel and venture investors rarely make an investment before they (or an affiliate of theirs) has met the founder and her team. In fact, these sophisticated investors typically put more faith in the management team than the business idea, and for good reason. Without the right team in place to execute on an idea, the company will invariably fail, or lose critical time to market while the right team can hopefully be found.

Related: The Secret to Fundraising Success? Think Friends, Not Investors

With private offerings, companies seeking capital reach out directly to the accredited investors that already know them, or to whom they have been introduced. They often employ broker-dealers, who introduce them to their network of investors, and those investors then get to know the company.

Even IPOs have a personal connection component. The main underwriter of the offering will take the company team out on what’s known as roadshow, designed to introduce the management team to the bank’s potential syndicate of dealers to persuade them to purchase the offering and to market the offering to their networks. Those dealers put a lot of weight into meeting that team and likely would not consider investing without a chance to get to know them personally.

Ben & Jerry’s raised capital through a DPO in 1984.

But not all securities crowdfunding takes the unfortunate approach that you need to separate the company from the investor and utilize technology platforms in the place of that personal interaction.

Direct Public Offerings are one example that have been around for decades—long before the term crowdfunding was invented. DPOs are federally exempt offerings that allow issuers to freely market shares in their company to their customers, followers and the general public. DPOs must be filed in the state where the offering is being conducted, and typically use one of two federal exemptions: Regulation D, Rule 504, which currently limits the raise to $1 million (although the SEC may up that to $5 million) but allows companies to file in multiple states; or Rule 147, aka the Intrastate Exemption, which typically has no dollar limit but requires the company and all its investors to be based in one state.

Ben & Jerry’s, for example, used a DPO to raise capital from Vermont residents in 1984. The young ice cream company’s quirky founders reached out directly to their fans. Every pint of ice cream came with with an ad encouraging customers to “Get a scoop of the action!” And potential investors had the chance to speak directly to the founders. These actions would not be allowed under Title III, which goes into effect in May, nor Vermont’s intrastate crowdfunding law. (That law, the Vermont Small Business Offering Exemption, does not require an intermediary portal, but limits public advertising to basic “tombstone” information).

More recent DPOs have included CERO Cooperative, EDFCFarm Fresh To You and People’s Community Market. (For more, see CuttingEdgeX).

In addition to Vermont, a handful of the 30 states that have enacted crowdfunding exemptions do away with the need for an intermediary. In Kansas, the Invest Kansas Exemption (IKE) makes no mention of a crowdfunding portal. Most IKE deals are conducted locally and offline. In Oregon, the Community Public Offering (CPO) was designed to be a community capital-raising tool, as its nickname suggests. Companies there are actually encouraged, not discouraged, to raise those funds directly from their communities via meet-ups that allow people to look the CEOs in the eye.

Related: Crowdfunding, Oregon Style

Three Direct Public Offerings You Can Invest in Today

Whether it’s a DPO, CPO, or another kind of offering that provides for and encourages direct and interpersonal connections, an investor is provided with a very valuable opportunity to meet the people behind the veil and to use their own personal assessments in addition to what a company states in its materials or ratings it’s received. And those personal connections then become a significant element for those inside the company now taking investments from people they know. If an offering is done right, the issuer maintains the right to refuse any potential investor, and that right in and of itself helps to significantly decrease any chance that the wrong kind of investor may come into a deal, especially when personal interactions are a cornerstone of the transaction.

The decisions companies make are likely highly informed by how connected the investors are to them. We have not experienced DPO investors who have abused that personal connection. What we have seen is a deeper, richer and more connected community as a result—a community of investors and companies who actually know each other!

John Katovich is the founder of Cutting Edge Counsel and Cutting Edge Capital, both committed to fostering quadruple bottom line practices for business, non-profits, cooperatives and communities, and providing strategies for the new impact economy.


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