Can Equity Crowdfunding Be Fixed?
Grow Your Business, Not Your Inbox
With the adoption last year of the Regulation Crowdfunding (Reg CF) exemptions by the Securities and Exchange Commissionprivate companies can now raise capital from all 230 million American adults. Until now, businesses have been restricted to fundraising from only 8.5 million accredited investors -- anyone who makes $200K a year individually or $300K a year jointly with a spouse, or has a net worth of $1 million.
While it’s only been four months, one thing is very clear -- equity crowdfunding, under the current rules, doesn’t work. Or as some might say, the exemptions were dead upon arrival.
Let’s understand why equity crowdfunding doesn’t work.
Financial review requirement by third party CPA
Reg CF requires that businesses raising more than $500K have GAAP Standard financials prepared and ready to share. While it’s important to provide potential investors with transparency into your business, the reality is that early stage companies generally don’t have GAAP financials prepared. And spending $5-10K on a CPA to prepare them is excessive.
Reg CF requires businesses to file a Form C with the SEC before they can solicit investors. A Form C is a 25-page document that can require upward of 50 hours of work to complete. You’re going to want a lawyer to review and help prepare some of it, so expect anywhere from $1-5K in legal costs, which most startups don’t have.
$1 million funding limit
Reg CF caps a business at raising $1 million in a 12-month period. For companies interested in fundraising smaller amounts, this isn’t a problem, but for many businesses who are interested in using Reg CF to raise more than $1 million, this becomes a non-starter.
This rule stipulates that if a business uses Reg CF to successfully raise capital and crosses $25 million in assets, they’ll be required to begin reporting as a public entity. This potentially creates a situation where a company could be forced to go “public” whether they’re ready to or not.
Post fundraising shareholder management
Under Reg CF all investors must be included on a company’s cap table. Often times when a startup has a large number of investors they use holding companies -- like Special Purpose Vehicles (SPVs) -- to clump them together and then assign a single manager to represent the group. This structure could be a great solution for companies equity crowdfunding from potentially thousands of people. Unfortunately, the SEC explicitly banned SPVs from Reg CF fundraising efforts.
But there may be hope on the horizon.
The Fix Crowdfunding Act (FCA) passed through the House of Representatives with a 394-4 vote on July 5, and now moves onto the Senate with major bipartisan support. This bill would work to improve the Reg CF exemption, hopefully resulting in rules that are more approachable for fundraising companies. The goal of Reg CF in the first place was to give early stage companies a new pathway to accessing capital. Under the current Reg CF rules, this doesn’t appear to have happened, but with these new modifications to the law, there may be hope on the horizon.
How would the Fix Crowdfunding Act (FCA) improve Regulation Crowdfunding?
Allow for Special Purpose Vehicles
The FCA would allow special purpose vehicles (SPVs) to be used for equity crowdfunding. Additionally, the number of investors that can be grouped together in an SPV was raised from 100 to 500 via the Supporting America's Innovators Act of 2016, which also passed the house on July 5. Similar to the FCA, it is still waiting for a vote by the Senate.
12(g) rule exemptions
The FCA would allow for companies using Reg CF to be exempted from the 12(g) rule. This would alleviate the concern many companies have of being forced to go public prematurely.
What still needs to happen to make equity crowdfunding work?
Testing the waters
If equity crowdfunding is ever going to work, companies must have the ability to attract interest and test the waters before they lay down thousands of dollars on lawyers and CPAs. The upfront costs currently required by Reg CF create too much risk for small businesses, which results in equity crowdfunding being an unrealistic option for most.
Increase funding limit up to $5 million
The limit a company can fundraise using Reg CF needs to be raised from $1 million to $5 million. This would make a big impact on the number of companies willing to use Reg CF, as many need to raise more than $1 million.
As the CEO and co-founder of FlashFunders, I clearly believe in the potential of Reg CF to help small businesses access capital efficiently, and connect with their customers in new and meaningful ways. While I fully understand the role of regulations and the important responsibility of the SEC to protect investors, the intent of the JOBS Act and Reg CF to inject new sources of capital into our small businesses is not being met.
My company and other equity crowdfunding platforms will continue to fight for small businesses and hustling entrepreneurs who need access to capital to innovate and build the next generation of great companies. Without further revisions to Reg CF however, the unfortunate reality is that many small businesses will be left unfunded -- as banks no longer lend and venture capitalists are only looking for “billion dollar ideas.”