The Securities and Exchange Commission has finally released proposed rules for the crowdfunding exemption of the 2012 Jumpstart Our Business Startups Act. Confirming initial indications, the rules do not require businesses raising capital under the exemption to verify that investors remain within legal investment limits.
The decision to allow people to invest in opportunities not vetted by regulators and without any income or net-worth verification is a symptom of the problems inherent in the law. The JOBS Act attempts to do the impossible: balance investor protection with a desire to enable companies to raise money from strangers all over the country with minimal red tape.
And I am saying this as one of the earliest proponents of a crowdfunding exemption. My involvement with what ultimately became the JOBS Act began in 2010 as I worked with entrepreneurs and artists attempting to raise capital. My colleagues and I encounter their frustrations every day at our firm, which focuses on the financing needs of small to medium-size businesses.
Commonly used securities laws make it difficult and expensive for small businesses and entrepreneurs to publicly offer investment opportunities if the investors are not wealthy ($1 million in net worth or $200,000 in annual income).
In 2010, through a non-profit that I co-founded called the Sustainable Economies Law Center, I submitted a formal petition to the SEC to create an exemption for offerings that capped the amount any single investor could put in.
Our original petition garnered media coverage and letters of support from all over the country, yet we heard nothing from the SEC. But a White House staffer became intrigued by the idea after we presented it to the SEC’s annual Forum on Small Business Capital Formation. Congressional hearings and a presidential proposal for a crowdfunding exemption followed, and after some changes in the House and the Senate, the final legislation – the JOBS Act – was signed into law April 5, 2012.
So how does it feel to be the one whose petition led to the creation of the JOBS Act?
I have many concerns about the final version of the crowdfunding exemption (Title III of the act).
Because of the large potential risk to investors posed by a completely unvetted offering, Congress felt compelled to impose onerous requirements on companies raising money under the crowdfunding exemption. These include:
• Requirement to use an online intermediary that could be costly and make the offering inaccessible to some investors.
• Requirement of reviewed or audited financials for companies raising more than $100,000.
• Prohibition on direct communication with potential investors.
• Requirement that investors can pull out at the last minute if they change their mind.
• Requirement to disclose financial statements to the general public until the company dissolves.
• Onerous ongoing reporting requirements.
At the same time, the risk to investors is still great because these offerings are completely unvetted. And without income or net-worth verification, investors stand to lose more than they can afford.
In fact, since submitting our petition, we have focused on a much better way to do investment crowdfunding. We now use a little known tool that has existed for decades called Direct Public Offerings that work under existing law. Yes, existing law!
While DPOs also allow public offerings of securities to all, whether wealthy or not, they must be filed with the states and are screened by state-level securities regulators who have a great deal of experience at spotting fraud and overly risky propositions. That is a big advantage over the JOBS Act, which prohibits state securities regulators from getting involved. Vetting by such regulators reduces the need for onerous limits. Generally, DPOs do not require audited or reviewed financials, caps on total amount raised or individual investments, ongoing reporting or limitations on communications.
One of our clients, Arroyo Food Co-op, a startup cooperative grocery store in Pasadena, is using a DPO to raise money from its community to open. The co-op is offering loans that pay a competitive rate of return. Because Arroyo registered the offering with the California securities regulators, there is no cap on the amount it can accept from each investor and it was not required to provide audited or reviewed financials.
With final rules yet to come, the ultimate fate of the JOBS Act crowdfunding exemption still remains to be seen.
Fortunately, Direct Public Offerings, which are legal today, are a powerful way to raise significant amounts of capital from the crowd.
Direct Public Offerings make investing in Main Street possible today. Let’s put crowdfunding to use and Americans back to work.
Jenny Kassan is chief executive of Cutting Edge Capital in Oakland.
