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Back in 2009, the founders of Kickstarter had a simple idea. They’d launch a website that would make it easy for artists, authors, filmmakers or anyone else to fund a creative project—without the help of big investors. Though Kickstarter didn’t invent the concept of crowdsourcing, the company has since facilitated more than $1.7 billion in funding for more than 84,000 projects, all while allowing creators to keep full creative control.
In March, the Securities and Exchange Commission took a page from the Kickstarter book, introducing new regulations that have been touted as crowdsourcing for equities. But rather than simply allowing a company to raise money for a specific product, the SEC’s new expansion of Regulation A (known as Regulation A+) makes it possible for small businesses to use the general public as company investors.
Whereas the original Regulation A only allowed small businesses to raise up to $5 million per year in funding, and only from accredited investors, Regulation A+ bumps the limit to $50 million annually and also allows non-accredited investors to contribute. That means small companies now have funding options beyond venture capitalists or private equity firms, and regular folks can get in on the action before a company goes public.
Regulation A+ seems like a win-win for both entrepreneurs and those eager to see small companies succeed. There’s just one problem: It may not actually work.
Fixing a Broken System
Back in 2012, President Barack Obama signed into law the Jumpstart Our Business Startups (JOBS) Act. “The intention of the JOBS Act was to make it a lot easier for entrepreneurs to get funding for their companies,” says Matt Romney, partner at the Kunzler Law Group in Salt Lake City, “but I don’t think it has actually accomplished that.”
Many of today’s securities laws trace their roots to acts passed during the Great Depression, including the Securities Act of 1933 and the Securities Exchange Act of 1934. Though these acts were intended to provide a safeguard for investors, the legislation was so vague that courts have had to step in to interpret and reinterpret them ever since.
The JOBS act was supposed to finally fix the broken system. “Everyone wanted [the act] to be simple. Everyone wanted it to take the ability to invest in startups out of the control of the super wealthy,” Romney says. “The problem is that the SEC has interpreted the JOBS act within the broken framework of the old securities regulations, and the new regulations don’t fix the problems that existed previously.”
The previous problems? Time and money.
Too Much Time, Too Much Money
Under Regulation A+, entrepreneurs have two tiers of crowdfunding options to choose from. Tier 1 allows companies to raise up to $20 million from accredited or non-accredited investors, without submitting audited financial statements. But there’s a catch: Companies must comply with securities laws in every state where they plan to raise money. This can be an incredibly time-intensive process, both in terms of the initial filing and continued compliance.
Tier 2 raises the annual funding cap to $50 million and bypasses state laws—but not state filing fees, which could total close to $100,000 for those planning to raise money nationwide. Tier 2 funding also requires nearly as much financial auditing as a full IPO.
“A Regulation A+ offering is such an expensive way to raise money that, for all intents and purposes, it becomes useless for startups,” Romney says.
An Alternative to Crowdsourcing
David Chase, managing partner at Advanced CFO Solutions, agrees that the new regulations aren’t entrepreneur-friendly. “Nobody’s doing Regulation A deals at this point; it’s too complicated,” he says. “It’s basically going public. It’s a lot of regulation for these companies to deal with that they haven’t had to deal with before.”
Instead, he recommends small companies use another JOBS act regulation to raise money. “If you’re willing to talk with accredited investors only, you should just do a Reg D and avoid a lot of the headache,” Chase advises.
Regulation D takes the crowd out of the crowdfunding equation. Under the rule, small companies can raise unlimited funds, but only from accredited investors. Chase says that’s not such a bad thing.
“I love the crowdfunding idea, but there’s so much liability that exists when you’re bringing in funds from non-accredited investors. That’s what scares people away,” he says. While the thought of hundreds or thousands of investors may be attractive to entrepreneurs, it’s likely to repel professional investors who prefer to have a bigger portion of the capitalization table and a greater say among the board of directors.