This post was originally produced for Forbes.
On May 16, 2016, Regulation Crowdfunding became effective. Arguably representing the biggest change to securities laws in 80 years, Title III of the JOBS Act passed in 2012 made investment crowdfunding legal subject to the issuance of regulations. Now, almost five years after the law passed, we have enough history with the rules to begin understanding what’s working and what’s not.
To work through the issues, I reached out to leading crowdfunding practitioners and experts for their reactions to the first nine months of practice in the space.
Bernard Loyd, a social entrepreneur and President of Urban Juncture, Inc., was among those who have had good experiences with the new rules. “Our experience has been that it provides efficient access to a broad pool of potential investors, many previously unknown to us. The online platform provides significantly better access to potential investors who share our passion for investing in economically-challenged, under-resourced urban enterprises with whom we otherwise would not have been able to connect.”
There is consensus that while Regulation Crowdfunding is working for some issuers, changes in the law or regulation would allow it to work for more entrepreneurs. Joy Schoffler is the Principal of Leverage PR, which represents clients in the crowdfunding space. Her reaction was typical, “I see it working for many companies already.”
The biggest challenge with the rules is the $1 million cap on crowdfunding offering. David Weild, IV, Chairman and CEO of Weild & Co., said, “The gross proceeds cap of $1 million is overly limiting. It should be eliminated altogether. Remember, there is a dollar-exposure-limitation ($5,000) per non-accredited investor so there is no need to limit the aggregate raise. Why do we care if there are 200 investors at $5,000 each or 20,000 investors at $5,000 each when the individual investor has the same risk limit? It is an arbitrary and poorly thought-through limitation.”
Kendall Almerico, a JOBS Act and crowdfunding attorney, largely agrees. “Congress set the $1 million limit far too low. It should be raised to at least $5 million.”
Alon Goren, Co-Founder, Crowd invest Summit, would go one step further, eliminating the restrictions on individual investors. “I think that anyone should be able to invest in what they want. I think that the limits are un-American, both on the size of the raise and on the investor.”
Congress is working on fixes, notes Philip Racusin, CEO of EnergyFunders. “The Fix Crowdfunding Act is a start in that it would allow for the use of special purpose vehicles to aggregate together investors (for the benefit of the investors and the business owner), and raises the maximum fundraise to $5,000,000.”
Special purpose vehicles or SPVs are used to manage large numbers of small investors, simplifying the capitalization table and ownership structure from the perspective of the issuer. SPVs are specifically prohibited by the current rules. Sara Hanks, CEO of CrowdCheck, and Douglas Ellenoff, Partner at Ellenoff Grossman & Schole LLP, a crowdfunding lawyer, agree that allowing SPVs is a necessary fix.
Another problem with the rules that experts say needs to be fixed is the prohibition on testing the waters. Title IV of the JOBS Act authorized the SEC to issue new rules for Regulation A offerings, raising the limits and specifically allowing issuers to expose a potential offering to the market publicly before launching the offering formally, even allowing the issuer to collect formal, non-binding expressions of interest in advance.
Hanks, Vincent Bradley, former CEO of FlashFunders, and Dan Baird, CEO of Crack the Crowd, among others, agree that adding testing the waters to Regulation Crowdfunding is essential.
Almerico explains why, saying, “No pre-launch marketing is allowed, which prevents a company from effectively soliciting investors until the offering is live. With a rewards-based campaign on Indiegogo or Kickstarter, successful companies spend months conditioning the market, generating leads and building up social capital before their launch. You cannot do that with Reg CF, and it means a company is behind the eight ball when they start their offering, because their marketing has not even begun yet.” He notes that the SEC has unilateral authority to change this rule.
Several practitioners, including, Weild, note that the limitations on marketing a crowdfunding campaign even after it launches are unnecessarily strict. “Don’t you find it fascinating,” he says, “that anyone can sell anything (except securities) on Kickstarter without limitation and buyers are given zero upside for their purchase money and the companies are only subject to criminal fraud? Regulation Crowdfunding gives the buyer upside. Why should securities be treated so differently from commerce, especially for smaller companies? There is no systemic risk concern for Government.”
Jenny Kassan, an attorney who consults with social entrepreneurs and women-led businesses on capital strategies including crowdfunding, noted, the marketing “restrictions are nonsensical,” adding, “this could be done without legislation.”
The JOBS Act requires crowdfunding issuers to file an annual report with the SEC. Kassan believes this requirement should be lifted, noting, “I think this would require legislation.”
While the rules do not define any of the costs of a crowdfunding offering, the rules do impose costs. Racusin highlighted the need to reduce the regulatory burden to reduce the costs of offerings, especially those over $500,000.
Among the other lessons learned, Weild noted, “The $1 million cap is not large enough to entice broker dealers and investment bankers to become involved so they don’t and the companies really could use the advice/involvement of experienced professionals.”
As the crowdfunding rules were being drafted, there was a lot of discussion about fraud and the corollary need to protect crowdfunding investors from it. Ellenoff noted, “That all of the expressed concern over fraud has not borne out as a legitimate reason for frustrating the legislation.”
Scott Picken, founder and CEO of Wealth Migrate, similarly noted, “There is significant demand and while the regulation is important to ensure that the consumer is protected, social proofing also goes a long way to protecting the consumer.” He added, “Most importantly investing is common sense and everyone has common sense.”