Earlier this month, the U.S. House of Representatives passed H.R. 2930, which is intended to clear the way for startups and other businesses to offer and sell securities in small offerings of up to $2 million, with individual investments limited to $10,000 or 10% of the investor’s annual income, whichever is lower. The proposed law, known as the Entrepreneur Access to Capital Act or “crowdfunding bill”, would amend Section 4 of the Securities Act of 1933 (“Act”) by creating a new exemption from the registration requirements of the Act. With such low investment limits, participation in qualifying private placements would be open to many more potential investors than is currently the case. This would be in stark contrast to the current situation where most private placements of securities are limited to “accredited investors,” a catergory that requires an individual investor to have a net worth of at least $1 million or an annual income exceeding $200,000.
Crowdfunding is just that – funding from a crowd. The idea is that many people invest a relatively small amount of money to finance something, typically a charitable cause or creative projects like a book or movie. Recently, the concept of crowdfunding has gained attention as a way to finance startup companies. Of course, crowdfunding for startup companies runs squarely up against the requirements and obstacles inherent in current securities laws, hence the need for revisions to such laws to accommodate this new funding approach.
Perhaps the most significant feature of the proposed crowdfunding law is that it would preempt state securities laws and permit “general solicitations”—a term understood to encompass most advertising and other solicitation methods that do not specifically target particular identified prospective qualified investors—which are currently strictly forbidden in private placements seeking an exemption under Regulation D. As a result, a crowdfunding offering could be conducted through social media websites such as Facebook, Rockethub or Kickstarter, and could make use of advertising and other publicity strategies that are to be avoided in a private placement under Regulation D.
To qualify as a Section 4(6) crowdfunding offering, issuers would have to comply with several conditions and restrictions intended to ensure that investors are aware of the risks of such investments generally. For example, issuers must warn investors of the speculative nature of the investment in startups, emerging business and small issuers and the limitations on the resale of the securities being purchased. In addition, each investor must complete a questionnaire to confirm their understanding of the investment risks. Other requirements:
• There must be a target offering amount identified by the issuer;
• 60% of the target offering amount must be raised before the issuer can close on the investment proceeds;
• The issuer must conduct a background check on the issuer’s principals;
• A notice must be provided to the SEC no later than the first day funds are solicited from potential investors;
Securities acquired in a crowdfunding offering would be restricted securities and could not be resold until after one year from the date they were acquired, with exceptions for sales to the issuer or an “accredited investor”.
Obviously, crowdfunding offerings may attract crowds. Currently, Section 12(g) of the Securities Exchange Act of 1934 requires companies with 500 shareholders and assets of more than $10 million to file annual and other periodic reports with the SEC. A company wanting to avoid public-reporting requirements might shy away from a crowdfunding offering that might attract a significant number of investors. To get around this problem, the crowdfunding bill provides that crowdfunding investors will not count toward the 500-shareholder limit.
The same day it passed H.R. 2930, the House also passed H.R. 2940, the Access to Capital for Job Creators Act. H.R. 2940 would result in amendments to Rule 506 of Regulation D to permit general solicitation of accredited investors.
Taken together, H.R. 2930 and H.R. 2940 appear to reflect Congress’s realization that improving access to capital by private businesses requires enlarging the pool of potential investors and easing restrictions on the manner in which capital is raised from accredited investors. These bills next move to the Senate, where Senator Scott Brown has proposed similar legislation in the form of Senate Bill 1791. In terms of key differences, S.B. 1791 would (a) cap individual investments at $1,000, (b) require that crowdfunding offerings be conducted through a crowdfunding intermediary (whereas H.R. 2930 would allow, but not mandate, the use of an intermediary).
Reading the tea leaves, it appears that the House and Senate Bills should be easily reconcilable, and the President has already stated his support for H.R. 2930. It seems reasonable to expect the legislation will be accelerated through Congress and could be on the President’s desk before the end of the year.
Earlier this year, I suggested the U.S. Government needed to create stronger incentives for the investment of private capital in private businesses and I described some of my ideas in that regard. One of those ideas involved loosening the “general solicitation” requirements of Section 502 of Regulation D. The current crowdfunding legislation clearly aims to address that issue. Although it seems a bit trendy and is not the structural change to securities laws I would have preferred, “crowdfunding” is an interesting approach to opening up new sources of capital for companies that really need it. Stay tuned.