Tag: Crowdfunding

Crowdfunded Companies Won’t Be Here Anytime Soon

Money

When the JOBS Act passed last spring, there was a huge surge on the future of crowdfunding. In pursuit of the riches of startup investing, many ignored the already successful world of Kickstarter, Indie Go Go, and others that already successfully fund projects. Those platforms don’t show the investor a pot of gold at the end of the rainbow. They show the investor the final project and maybe the chance to purchase one or participate.

By switching to equity fundraising, the focus would switch to the potential financial reward and perhaps less on the value of the project. Critics wailed about the onslaught of fraud. Proponents praised the unleashing of entrepreneurial capital. The lawyers and regulators worried about how to implement this new capital raising regime.

Congress didn’t make it easy. They chose do throw out the original crowdfunding law proposed for the JOBS Act and replaced it with a very cumbersome and difficult new piece of legislation. They gave the Securities and Exchange Commission 270 days to come out with the regulations. That’s on top of the huge pile of regulatory mandates passed 2 years ago with Dodd-Frank.

We have seen no inkling that the SEC has come close to proposed regulations. With the departure of Mary Shapiro, the SEC is down to four commissioners. Two of whom have publicly voiced their concerns about crowdfunding. Even if the SEC can gather three out of four of the commissioners to agree on proposed regulations, there will be a lengthy comment period and likely re-writing to get to the final regulations.

In addition to the SEC, FINRA will need to create a regulatory regime for the registration of crowdfunding portals. To get a taste of how difficult this going to be, you can take a look at the first baby steps of regulatory work that came from FINRA.

FINRA is inviting prospective crowdfunding portals to voluntarily file an interim funding portal form. The filing is meant to help FINRA develop rules that reflect the funding portal community and its business. It is not an application and does not get anyone any closer to having a working equity crowdfunding platform.

For a taste of the difficulties take a look at the last question:

Please describe how the [Funding Portal] addresses the requirements for funding portals under the JOBS Act. In particular, please describe how the [Funding Portal] would
(i) address investor education;
(ii) take measures to reduce the risk of fraud with respect to funding portal transactions;
(iii) ensure adherence to the aggregate selling limits; and
(iv) protect the privacy of information collected from investors.

The successful crowfunding portals are going to have to master difficult regulations, successfully court attractive investment opportunities, master the 50 states of privacy legislation, come up with effective investor eduction tools, and successfully attract investors willing to write checks.

I still think crowdfunding will end up being a minor league system for the investment banks. They have the resources to conquer these hurdles. They can use the database of investors to mine for more conventional investment opportunities. They can use the few successful crowdfunded companies to sell bigger opportunities for raising more capital. It seems to me that we are still many, many months away from seeing the first crowdfunding portal under the JOBS Act.

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What Does FINRA Think About Crowdfunding?

The crowdfunding provisions in Title III of the JOBS Act provide an exemption from registration under the Securities Act of 1933 for securities offered by through crowdfunding, provided the numerous requirements are met. An intermediary that seeks to engage in crowdfunding must be registered as a broker-dealer or a funding portal. I expect many people are looking at what the regulatory requirements are going to be for this new type of entity. The JOBS Act also requires that a funding portal be a member of an applicable SRO, but limits the examination and enforcement authority of the SRO over registered funding portals to rules “written specifically for registered funding portals.”

FINRA issued Regulatory Notice 12-34 soliciting public comment on the appropriate scope of FINRA rules that should apply to member firms engaging in crowdfunding activities, either as funding portals or as brokers.

Commenters are encouraged to identify the types of requirements that should apply to registered funding portals, taking into account the relatively limited scope of activities by a registered funding portal permitted under the JOBS Act. Comments are particularly requested about possible rules concerning supervision, advertising, anti-money laundering, fraud and manipulation, and just and equitable principles of trade.

I think would-be crowdfunding portal developers are going to have a hard time dealing with the know-your-customer rules required in setting up an account.

Would established firms set up crowdfunding portals. FINRA is clearly anticipating that some of its member firms will do so. And why not? I’m sure a brokerage firm could view a crowdfunding portal as a minor league, allowing them to farm prospects for bigger alternative investments.

FINRA is already looking at potential conflicts.

FINRA also requests comment on whether engaging in crowdfunding might present special conflicts or concerns for a broker-dealer, such as might arise if a registered representative were to recommend that a customer visit the firm’s crowdfunding site.

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Crowdfunding the Crowdfunders

With President Obama set to sign the Jumpstart Our Business Startups Act on Thursday, it seems the race is on to create a crowdfunding portal and to start making money. Crowdfunding has been around for a long time and the use of a crowdfunding portal dates back several years. Now there is a crowdfunding accreditation program and a trade association.

Crowdsourcing.org has launched the Crowdfunding Accreditation for Platform Standards program to promote the adoption of best practices. Eight platforms have obtained the green ribbon since the program started on March 21:

PleaseFund.Us
Crowdcube
Crowdfunder 
Grow Venture Community
GreenUnite
HelpersUnite
SymBid
Fundrazr

David Marlett announced the formation of the National Crowdfunding Association, “the professional organization of all companies and individuals with an interest in crowdfunding. The NCFA is charged with “supporting, educating and protecting the American crowdfunding industry.” According to the press release, over “fifty companies and individuals dedicated to the nascent crowdfunding industry came together to form the association.

Mr. Marlett claims to have launched the first crowdfunding agency on March 21, 2012 and is now the executive director of the National Crowdfunding Association. They even have twitter accounts, Facebook pages, and blogs. (Does that make it real?)

Over on the transcedant Quora, questions keep coming on Crowdfunding: Crowdfunding will explode after the JOBS Act passes. How can I invest in a crowdfunding site?

My original thought on crowdfunding was a line from Groucho Marx, “Please accept my resignation. I don’t care to belong to any club that will have me as a member.” if these investments and opportunities are so good, why hasn’t a professional investor delivered the funding? Why would the company want my $1,000? Maybe they are not that good? Maybe they are inexperienced? Maybe they are just looking to make a quick buck?

In looking at the race to create crowdfunding portals and associations of portals I have the same concerns. There are plenty of existing sites and existing companies that could easily choose to dominate the marketplace, if they so choose. The Securities and Exchange Commission has to craft a regulatory structure to deal with the CROWDFUND Act. That will take months.

For now it seems there will be tussle for attention in the space. The megaphones are out. There will be losses.

How Do State Regulators Really Feel About the JOBS Act?

The House of Representatives recently voted to pass The Jumpstart Our Business Startups (JOBS) Act (H.R. 3606), a collection of several bills focused on barriers to capital formation. I’m focused on the bill because of mostly because of the Access to Capital for Job Creators section that would override the ban on general solicitation and advertising under Regulation D.

I welcome some sensible changes to Regulation D because I find the ban a bit vague as part of the fundraising process. Private fund managers could use guidance from the SEC on what is allowed and what is prohibited by the ban.

On the other hand, knowing the general ban exists makes it easy to dismiss scams and spam spinning tales of possible investment opportunities. That unsolicited message is either a straight-up scam or a naive entrepreneur who thinks they can operate without competent advice. Either way you can easily dismiss the opportunity.

Another provision of the JOBS Act that I found interesting is the Private Company Flexibility and Growth Act. The main purpose is to raise the thresholds under Section 12(g)(1)(A) of the Exchange Act. Currently under that provision, private companies with more than 500 shareholders and a big stream of revenue effectively have to become public companies. That shareholder limit forced Google into going public and most recently is forcing Facebook to go public.

The centerpiece of the JOBS Act is the new crowdfunding platform. Currently, platforms like Kickstarter are prohibited from offering equity. Project sponsors have to ask for donations, offer schwag, or pre-sell products. All of which seems to work very well.

Commentators like William Carleton think the concept of crowdfunding will be great for entrepreneurs. The Wall Street Journal has a point-counterpoint this morning on crowdfunding:

Like most stuff coming out of Congress, even if the concept is good I think Congress is likely to screw up the drafting of the law.

That is my view of the JOBS Act. Most of the concepts are good, but the execution is poor. I think Congress is missing the balance between investor protection and access to capital. That opinion is shared by the North American Securities Administrators Association. Here is a snippet from an editorial by Jack E. Herstein, president of NASAA:

The most jobs this cleverly named bill may create are jobs for fraudsters, like the Nigerian scammers, penny-stock pitchers and Ponzi schemers already lurking behind the Internet to cloak their schemes.

The Senate is mulling over their version of these bills where it seems to have bi-partisan support. President Obama has also thrown his support to some of the concepts in the JOBS Act. It seem likely that something will pass. According to Talking Points Memo it looks like Senate Majority Leader Harry Reid is willing to trade support for the JOBS Act for approval of some judicial nominees.

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Crowdsourcing the Crowdfunding Exemption

There is a growing movement to create a new crowdfunding regime for raising capital. The models seem to draw inspiration from Kickstarter, a platform to fund creative projects. I say that because each time I see a draft bill it talks about an internet-based intermediary as part of the exemption.

President Obama endorsed the idea of a crowdfunding exemption. That has lead to three bills in Congress, plus a proposal being generated by NASAA as a state-run alternative.

President Obama cheered for crowdfunding as part of the American Jobs Act unveiling. The statement talks about the millions raised through Kickstarter in the form of donations. That’s not exactly right. The offering is sometimes a pure donation, but more often is linked to a product in development.

The Entrepreneur Access to Capital Act (H.R. 2930) permits “crowdfunding” to finance new businesses by allowing companies to accept and pool donations up to $5 million without registering with the SEC. It would limit individual investments to the lesser of $10,000 or 10% of an investor’s annual income. An amendment requiring a notice filing with the SEC was rejected as was an amendment that would have barred felons from being involved.

NASSA is putting together a model exemption for use at the state level. The various state level regulators are trying to craft this model.

The Democratizing Access to Captial Act (S.1791) was introduced by Senator Scott Brown. This bill is being supported by the Wefunders, who is in the business of being a platform for capital crowdfunding. Unlike Kickstarter, it’s only open to accredited investors.

Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2011 (S. 1970) was  introduced by Senator Merkley. This bill has the right acronym.

What they all have in common is some cap on the total funds that can be raised and a cap on how much someone can invest.

I’m all for making it easier for entrepreneurs to have easier access to capital. The registration and legal limits on capital-raising deter lots of projects. However, they also vet projects. To some extent, excluding the unworthy. It also tends to deter lots of worthy projects.

I like the project crowdfunding at Kickstarter. There is no expectation of riches, other than whatever trinket or completed example of the project they promise to you in exchange for your funding. I have no concerns about the dilution of shares, executive compensation, ratchets, and follow-up rounds.

Capital crowdfunding should be an interesting experiment. I predict it will create lots of new jobs and fund lots of interesting projects.

I also expect that it will be suspect to fraud. I expect that there will be many disappointed small investors who expected to reap fortunes, instead being stuck with worthless shares in failed companies or companies that existed only to funnel cash to fraudsters.  The extent of that fraud will depend on how well Congress crafts a crowdfunding bill. I expect they will come up short.

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I’m an NFL Owner

Sort of.

The Green Bay Packers want to expand Lambeau Field by 6,700 seats, add new gates and new video boards. To finance the improvements, the team ownership decided to sell additional stock in the ownership corporation. Since the Kraft family is unlikely to be selling the Patriots anytime soon, I was willing to part with some football loyalty and some cash to get my own piece of the NFL pie.

Unlike the rest of the National Football League franchises, the Green Bay Packers franchise is owned by non-profit, community-based organization, Green Bay Packers, Inc. The corporation is required to be nonprofit sharing and that no shareholder may receive any dividend or pecuniary profit by virtue of being a shareholder in the corporation. Any increase in value or operating profits and any proceeds upon liquidation of the corporation will go to community programs, charitable causes or other similar causes. If you add in limitations in stock ownership and transfer restrictions, it’s virtually impossible for anyone to recoup the amount initially paid to acquire the stock. That makes it a completely non-economic investment.

Is it a security?

Here is what the offering document says:

Because the Corporation believes Common Stock is not considered “stock” for securities laws purposes, it believes offerees and purchasers of Common Stock will not receive the protection of federal, state or international securities laws with respect to the offering or sale of Common Stock. In particular, Common Stock will not be registered under the Securities Act of 1933, as amended, or any state or international securities laws. The Common Stock will not be approved by the Securities and Exchange Commission or any state or international regulatory authority nor will the
Securities and Exchange Commission or any state or international regulatory authority approve the Offering or the terms of the Offering.

Under the Howey definition of an investment contract, you need (1) a common enterprise and (2) to depend “solely” for its success on the efforts of others. Certainly, the Packers’ stock meets those two prongs. The third prong is an expectation of profits. That is not true. However the definition of “security” in the Securities Exchange Act of 1934 includes “any note, stock, treasury stock…” The interests in the Packers are clearly stock and seem to fall into the definition of security.

What do you get?

A certificate:

The certificate is designed in the timeless tradition of classic stock certificates. The 12 inch by 8 inch certificate is printed on exquisite paper using a classic engraved steel plate process. It features an artistic representation of heritage. The record of your ownership will be secure, and you will be able to display your ownership with pride.

Is this Crowdfunding?

This is the current state of crowdfunding. You can’t offer securities without going through the registration process or finding an exemption. But you can still raise funds from a large group of people. Just don’t offer a share of the profits or stock. That’s how the kickstarter crowdfunding platform works. You get an over-priced product or a t-shirt or some other token of appreciation. As a backer, you do not have visions of early retirement because you just bought a piece of ownership in a multi-million dollar idea.

A Packers’ alternative would be to have merely offered a certificate of appreciation or tufts of grass from Lambeau field. But they offered the ability to say “I’m an NFL owner.”

I’m supporting a multi-million dollar idea. On Any Given Sunday, any team in the NFL can beat another. A team from tiny Green Bay, Wisconsin can still generate the revenue to field a competitive team and win the Super-Bowl.

I still prefer that the Patriots win the Super Bowl.

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Crowdfunding

It’s hard to raise capital. The regulatory restrictions imposed by securities laws make it harder to do so. As any bright-eyed entrepreneur with a dream project will tell you, the lawyers and the securities laws make it very expensive and time consuming to raise capital for a small project.

The central goal of the Securities and Exchange Commission is to facilitate companies’ access to capital while at the same time protecting investors. More often than not, the securities laws and regulations are put in place due to some prior malfeasance. Limitations on the sale of securities are in place because there were (and still are) lots of shady characters trying to make a quick buck by de-frauding investors.

The Obama administration and the Congress think the regulatory burdens need to be removed to encourage small business capital formation. I’m going to guess that they are fans of Kickstarter, a website that allows entrepreneurs and artists to raise capital for their projects. (I’m also a fan and have contributed to some projects.)

SEC Rule 504 allows a public offering to investors (including non-accredited investors) for securities offerings of up to $1 million. There is no limit on the type of investors, so they need not be accredited investors.  There are no prescribed disclosures and no limitations on resales of the securities. The Rule generally does not allow companies to solicit or advertise their securities to the public.(Of course, the antifraud and other civil liability provisions of the federal securities laws are still applicable.)

However, these offerings are subject to state “blue sky” regulation. That means having to jump through the patchwork of state securities laws, depending where your target investors are located.

How does Kickstarter get around this? It doesn’t. Capital for Kickstarter projects cannot be for securities or lending. As a patron, you do not get your capital returned. Often, you’ll get the end product that the artist or entrepreneur was hoping to produce. (My son is patiently waiting for our pack of trebuchettes to arrive.)

Generally, the term “crowdfunding” is used to describe a form of capital raising whereby people pool money, generally as small individual contributions, to support a specific goal. Since the capital raising did not provide an opportunity for profit participation, initial crowdfunding efforts did not raise issues under the federal securities laws.

The Entrepreneur Access to Capital Act would create a new exemption for small companies, allowing them to raise up to $5 million. The limitation would be that investments are limited to the lesser of $10,000 or 10% of the investor’s annual income.

President Obama cheered for crowdfunding as part of the American Jobs Act unveiling. I failed to find and proposed legislative changes in his proposed bill.

I’m for fueling entrepreneurial growth in this country. I’m concerned that the changes could lead to an onslaught of fraud. I think Kickstarter works well because you are funding the effort. You are not seeing dollars signs.

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