By Joseph Santiesteban
Part of President Obama’s recently released American Jobs Act proposes altering the Securities Act of 1933’s rules on Initial Public Offerings (IPOs) to include a crowdfunding exemption and to raise “the cap on ‘mini-offerings’ from $5 million to $50 million.” The goal is to reduce burdensome regulations on small businesses that currently have limited options in seeking financing by taking advantage of social networks’ ability to “crowdfund,” in which a large number of investors contribute small sums of money to projects.
Currently, the Securities Act prohibits firms from publicly selling or advertising stocks or other interests in its firm’s profits without first going through the onerous process of registering an IPO with the SEC (Form S-1). This process often prices out many small firms that can’t afford the time and expense of filing. The primary exception to the standard IPO process is a “mini-offering” made pursuant to Regulation A. These offerings require a less thorough inspection by the SEC, but are currently limited to offers of less than $5 million.
There is growing support to update these laws from President Obama, Republicans in the House of Representatives, and the SEC. President Obama suggested the idea with the release of his American Jobs Act on September 8, 2011. The House of Representatives’ Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs held a hearing on “Crowdfunding: Connective Investors and Job Creators” on September 15, 2011. During his opening remarks at the hearing, Representative Patrick McHenry (R-NC) said, “All Americans, not just banks and venture capitalists, should be able to invest in the next Google or Apple.” Testifying at the hearing, SEC official, Meredith Cross, said that she sees real benefits in easing restrictions if it can be done in a way that “wouldn’t present significant concerns of fraud.”
Proponents’ primary argument for updating the laws is that it will increase access to capital for small businesses by lowering the cost of seeking financing. Many crowdfunding websites already connect investors with innovators, but currently, investors are not allowed to accept a share of the profits. Instead, in return for their small investment, investors receive other benefits like a sample of the innovator’s products or, if available, a tax deduction. Most crowdfunding websites have little upfront costs and take a percentage of the money invested, making it a significantly cheaper alternative to classic fundraising techniques. However, proponents argue that this market is currently underserved, by both innovators and investors, because SEC regulations prevent investors from accepting a share of the profit. President Obama’s proposed crowdfunding exemption would remedy this problem by exempting offerings of less than $1 million from registering with the SEC.
Berkeley Law Professor Robert Bartlett says that any movement to crowdfunding will have to address how to update the laws in a way that provides adequate investor protection. This goal was one of the justifications for the Securities Act of 1933, and any new law likely will have to accommodate it for crowdfunding to be successful. Professor Bartlett says that while preventing fraud is a significant concern, capping the amount investors can contribute could potentially “allow companies to spread the cost of entrepreneurial development,” thus mitigating the impact of fraud on any one individual.
To learn more about current crowdfunding sites, please visit: