By Gregory Roberts, Bloomberg News
March 24, 2016 — New online crowdfunding Web portals won’t go live until mid-May, but a key House Republican is already renewing efforts to ease existing restrictions on how much money companies can raise via the innovative technique.
Rep. Patrick McHenry (R-N.C.) introduced legislation (H.R. 4855) that would lift to $5 million the amount that an individual venture can raise under the crowdfunding exemption from securities law in the 2012 JOBS Act. That represents a fivefold increase on the $1 million cap now in the law.
McHenry, who is deputy majority whip and serves on the Financial Services Committee, has introduced legislation in the past with a $5 million limit.
He is working with House Majority Leader Kevin McCarthy (R-Calif.) on a legislative “Innovation Initiative” to foster financial-technology businesses. They haven’t said much about what will be in the package, although McHenry mentioned crowdfunding as an area he plans to address in his March 17 remarks to a fintech group.
McHenry supports a “JOBS Act 2.0” that will “allow us to open up and expand the market even further,” Kim Wales, a board member of the Crowdfund Intermediary Regulatory Advocates (CFIRA) trade association, told Bloomberg BNA. Wales also provides regulatory advice to crowdfunders through her firm, Wales Capital, in New York.
The Securities and Exchange Commission (SEC) issued its first-ever rules for crowdfunding under the JOBS Act in October, setting May 16 as the launch date for the online “funding portals” established by the law. The law requires crowdfunders to raise money through SEC-registered intermediaries: either funding portals or securities brokers. Interested investors visiting a crowdfunding company’s website will be directed to the intermediary handling that stock offering.
“Where we are at the moment is that the people who want to be intermediaries have started to apply to the SEC and they’re going through the process,” Sara Hanks, chief executive officer of CrowdCheck in Alexandria, Va., which helps crowdfunders and investors navigate the process, told Bloomberg BNA. “But the curtains haven’t been drawn.”
50 Applications Expected
Federal regulators have said they expect about 50 applications for registration as funding portals, with another two dozen brokers seeking intermediary status, Chris Tyrrell, chairman of CFIRA, told Bloomberg BNA. Tyrrell also runs OfferBoard, a broker in Princeton, N.J., that plans to serve as a crowdfunding intermediary.
“I think it will be a fairly slow start to the market,” he said. “Securities law and securities activity is a difficult area in which to innovate.”
Crowdfunding refers to the raising of money from many investors or contributors who typically each put up a small amount of money. The idea is not new — political campaigns have long been financed by a form of crowdfunding — but it’s been energized by adoption of the Internet as the fundraising vehicle. A well-known example of online crowdfunding is Kickstarter, which has raised nearly $2 billion to underwrite hundreds of thousands of films, musical productions and other creative projects, with contributors sometimes receiving small gifts for participating in the campaigns, but not a financial interest in the supported ventures.
The kind of crowdfunding that the JOBS Act primarily addresses is equity crowdfunding, in which companies sell shares of stock to the public. That process ordinarily requires compliance with SEC regulations on the public sale of stock, which are costly and time-consuming to satisfy. The goal of equity crowdfunding is to expand the fundraising ability of companies, especially startups and small businesses that can’t afford the expense of complying with the standard SEC rules.
The JOBS Act carves out a crowdfunding exception to the SEC requirements, with qualifications. Besides the $1 million cap on a company raising money, it limits an individual investor with an annual income or net worth of less than $100,000 to total crowdfunding investments per 12 months to the greater of either $2,000 or of 5 percent of the lesser of the investor’s income or worth. If both an investor’s annual income and net worth are equal to or more than $100,000, then the cutoff is 10 percent of whichever of those two amounts is smaller — but in no case can an investor’s total crowdfunding outlays exceed $100,000 in a 12-month stretch.
Risks to Investors?
Wales told Bloomberg BNA she would favor loosening the restrictions on the size of investments.
“The question is, how much can you exempt (from SEC rules) before you put Grandma at risk?” said Cyrus Habib of Perkins Coie LLP in Seattle.
As a state legislator, Habib successfully sponsored a 2014 crowdfunding bill in Washington state, one of more than 20 states with crowdfunding laws. The state laws apply only to crowdfunding by companies and from investors within each individual state, which is inimical to Internet operations. The JOBS Act trumps those state laws.
The JOBS Act rules also govern advertising of a crowdfunding effort and communication of information to investors. The bill passed with bipartisan majorities in both the House and Senate and was signed by President Barack Obama, who had endorsed the concept early in the process. All “no” votes came from Democrats.
Bartlett Naylor of the nonprofit advocacy group Public Citizen in Washington, told Bloomberg BNA that his organization views crowdfunding as akin to Nigerian Internet frauds and does not think the investor protections are adequate.
“Crowdfunding is just an invitation to scam people who are unsophisticated,” he said.
Crowdfunding typically taps a fundraiser’s existing networks of friends, relatives, neighbors and social media contacts, Tyrrell said.
“I do think it’s going to be primarily used by startup companies that are just getting started and that basically need seed capital,” he said.
Other likely candidates for equity crowdfunding include franchisees and small enterprises such as a coffee shop or yoga studio looking to add outlets, he said.
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