Crowdfunding potential unrealized where needed most

TED HOWELL, a lawyer that specializes in helping tech startups, thinks most existing investors would not utilize crowdfunding.
 / PBN PHOTO/ MICHAEL SALERNO
TED HOWELL, a lawyer that specializes in helping tech startups, thinks most existing investors would not utilize crowdfunding. / PBN PHOTO/ MICHAEL SALERNO

Before crowdfunding changed the world of startup investing, the federal government was supposed to change the rules of crowdfunding.
With the Jumpstart Our Business Startups Act of 2012, Congress tried to usher in a new era of entrepreneurs raising money from small investors across the country over the Internet.
But the law required the Securities and Exchange Commission to write the regulations to put the new rules into practice and two and a half years later the agency has yet to do so.
Although the JOBS Act garnered bipartisan support, it wasn’t without controversy and concerns that it could open the door to fraud and abuse have caused regulators to move cautiously.
Securities regulations exist in part to protect small investors from losing their shirts to con artists, Ponzi schemes and boiler-room operations – outcomes critics of the JOBS Act said might result from loosening the rules on crowdfunding.
With the law still in flux, crowdfunding remains a source of mostly unrealized potential in secondary markets like Providence, where the startup community is often described as starved of seed capital.
Many small businesses here use sites such as Kickstarter and Indiegogo to raise donations (“investors” are usually compensated with gifts or access to the new project), but for the larger sums that come from return-seeking investors, startups still largely rely on traditional angels or venture capitalists.
“I haven’t really seen that much of an impact locally,” Theodore “Ted” Howell, a business law attorney in Providence who specializes in working with early-stage technology companies, said about crowdfunding. “As a practitioner, a lot of us are conservative and would rather go with what we know rather than try something new and get in trouble with the SEC. I don’t want to be the test subject where the SEC says your certification was inadequate.” Among the numerous provisions of the JOBS Act intended to ease regulatory burdens and costs on small companies, two changes in particular impact early-stage investing and crowdfunding.
The first, Title II, removed the prohibition on marketing equity investments to the general public, an integral part of any crowdfunding platform. It went into effect with a final SEC rule in the summer of 2013.
The second, Title III, the one still under SEC review, would make it possible for small companies to offer stock to nonprofessional investors, defined by the government as having less than $1 million in assets (excluding their home) or making less than $200,000 per year, without going through a formal initial public offering process.
In order to provide some protections for those small investors, the JOBS Act places a $2,000 cap on each nonaccredited investment and $1 million limit on what a company can raise from those nonaccredited investors in each round.
Without Title III, crowdfunding platforms such as AngelList only work with professional investors, limiting their potential capital pool to more-traditional sources.
“I would imagine startups are impacted to a certain extent because there is one less vehicle to obtain funding and when the [SEC] rulemaking is complete there will be a whole new group of investors in those companies,” said Howell, who has explored AngelList in the past. “By the same token, I think most existing investors would not utilize crowdfunding because it can only go up to $2,000 per investment and they already utilize an exemption [from registering with the SEC] that has worked for a long time.”
From the investor point of view, if crowdfunding is wildly successful, the additional capital entering the market could theoretically drive up valuations, making the deals they normally do more expensive. Another potential hurdle Howell said he sees to crowdfunding startups is the level of individualized negotiation and attention that most seed-stage deals involve.
“Unless you are dealing with a rock star who can set their terms and have people take them, usually the terms, like how much of the company they get for their money, are negotiated by a lead investor,” Howell said.
On the advice of their attorneys, some venture-capital funds, already careful with their words, have become even more reticent to discuss new projects publicly.
Howell said this is likely out of concern that comments about raising money will be interpreted as solicitation of nonaccredited investors, which remains illegal. When founders pitch their startups at an accelerator-pitch night, for example, the accelerator doesn’t want to be accused of making an unregistered public offering.
When Rhode Island’s Slater Technology Fund announced its new state-sponsored venture fund for energy startups, for example, managers cited the JOBS Act as reason not to take open questions from the press on it.
So when might the JOBS Act’s unaccredited crowdfunding provisions actually go into effect?
SEC spokeswoman Judy Burns declined to comment on why the rulemaking process has taken so long, but pointed to Commission Chairwoman Mary Jo White’s testimony before the Senate Financial Services and General Government Subcommittee last spring as evidence of commitment to it.
“Completing the rulemakings and studies mandated by Congress in the Dodd-Frank and JOBS Acts remains among my top priorities,” White told the Senate panel. •

No posts to display