On April 5, 2012, the President signed the JOBS Act into law with full bi-partisan support and much fanfare. Title III of the JOBS Act called for implementation of Equity Crowdfunding and was full of promise to help startups and main street small business raise much needed capital and to help create jobs. As we’ve previously pointed out, Kauffman Foundation research has established that were it not for new businesses, there would be no net job growth in the U.S. Economy.”
Fast forward nearly three years and Title III is yet to be implemented and is virtually dead in the water with zero jobs created.
Meanwhile, the United Kingdom has leapfrogged the U.S. in equity crowdfunding by enacting rules in 2012 resulting in over 2,000 companies raising over £175 million with no confirmed instances of fraud. Moreover, according to a recent report, 60% of these crowdfunded companies have increased employment following a successful campaign.
In our previous comment letters to the SEC, we we requested that these Proposed Rules be modified to 1) Reduce Costs Burdens in Crowdfunding, 2) Provide for Testing the Waters in Crowdfunding and 3) Balance Broker-Dealer and Funding Portal Regulatory Regimes. These previous letters received over thirty additional follow-on letters in support of these concepts.
In our latest Comment Letter, entitled “Keep Crowdfunding Simple,” we re-iterate these requests and ask the Commission to promptly enact final equity crowdfunding rules with a focus on main street capital raising rather than Wall Street trading.
The original Title III bill was far from perfect but did outline a framework for a workable equity crowdfunding industry. The October 2013 Proposed Rules, however, included many new, extremely burdensome (expensive) requirements and restrictions, including providing for extensive ongoing disclosure obligations and ongoing requirements to file financial statements.
Secondary Market Trading
These sorts of additional, ongoing requirements might make sense for large, publicly traded corporations, but they simply don’t make sense for small, private startups and small businesses. We understand that ongoing annual disclosures and audited financials help Wall Street more accurately price securities, which enhances both liquidity and market confidence. But regulating startups and small business like they are public companies just will not work. By adding additional requirements similar to those faced by public companies, the proposed rules added needless layers of complexity and expense, making Title III equity crowdfunding so complicated, expensive and risky that it is currently unworkable for startups and small businesses.
Further, this line of thinking fails to recognize a key point: Small businesses and startups do not want their securities traded and do not want public disclosure obligations. This is especially true for main street companies seeking $1 million or less. These companies are worried about hiring employees, healthcare costs, regulatory burdens and generating revenue – the last thing they are concerned about is their latest stock price, transfer agents, public filings, audited financials and Wall Street financial analysts.
No matter the law and what secondary markets may emerge, the vast majority small businesses and startups will restrict their stock from being traded by contract. Just ask SecondMarket:
“I can understand why companies are really reticent [to have their shares traded], and its why we changed our model back in 2011. The companies were being really proactive. We heard from the companies saying, “Quite frankly, [selling shares] should be outlawed because its so distracting. We don’t want anything like [what happened at Facebook] to develop and we’re looking at ways to change the bylaws in our businesses so it can be explicitly outlawed.” Venture firms have said when founders are forming their companies, they’re [outlawing share sales] at that stage. That was when we realized a different solution was going to be required.”
-Bill Siegel, Interim CEO at SecondMarket
As a standard practice, virtually every startup has contractual restrictions on transfer of their securities – and for good reason. These companies want to know who’s on their cap table, do not want burdensome administrative obligations, and want to focus on managing their business rather than managing their shareholders.
Shares of startups and small businesses have never been publicly tradable and they do not need to be. Investing in startups and small businesses is risky and anyone who needs access to near term liquidity should not be investing in the asset class.
Streamlining Capital Raising Process
We urge the commission to revisit the Title III Equity Crowdfunding proposed rules with an assumption that there will be no secondary market and that investors should go in with the understanding that these are a highly illiquid, “buy and hold” investments.
Namely, this means:
- Limiting ongoing disclosure requirements to the statutory level
- Eliminate ongoing annual financial statement requirements
- Exempt companies with contractually restricted shares from ongoing annual disclosure requirements
- Implementing “Testing the Waters”
By taking these steps, we believe that a streamlined, effective equity crowdfunding rule could be quickly and simply implemented.
While the secondary market and liquidity is typically great for investors, in this case it harms investors, small businesses, job seekers and the economy as a whole. In short, we urge the Commission to keep crowdfunding simple for main street and save the secondary market and Wall Street trading for Regulation A and larger companies.
This post was written by James Han on February 20, 2015