By John Berlau, CrowdfundBeat Sr. Guest Editor director of the Center for Investors and Entrepreneurs, Competitive Enterprise Institute.
As 2015 comes to a close, it’s time for year-end retrospectives, in which the past year is proclaimed the “year of” something. So in that spirit, I declare 2015 to be the Year of Equity Crowdfunding. Some proclaimed 2012 the “Year of Crowdfunding.” But 2015 has been the year that regulatory barriers to equity crowdfunding slowly but surely began to fall at the state and federal level.
As I explain in my recent paper, “Declaration of Crowdfunding Independence,” significant regulatory roadblocks – including laws more than 80 years old – have stopped entrepreneurs from offering any type of monetary reward that could be considered a “return on investment” in crowdfunding campaigns. It didn’t matter that individuals funded these campaigns in relatively small amounts. As I noted in the paper:
“[W]ere an innovator on a crowdfunding platform to offer a share of profits in the project, that would be considered a ‘security’ under federal law, and he or she would have to wade through much of the same red tape as a Fortune 500 company listed on the New York Stock Exchange.”
This includes the onerous mandates of the Sarbanes-Oxley Act of 2002 and the Dodd-Frank “financial reform” of 2010.
Ordinary would-be investors were often prevented from growing wealthy with the innovators they funded, simply because outdated securities regulations made it next to impossible. As I note in a Dec. 28 letter in The Wall Street Journal, when technology startup Oculus Rift was acquired by Facebook for $2 billion in 2014 after a successful crowdfunding campaign, “all Oculus funders got out of the deal were T-shirts, posters and fancy headsets,” because of “the morass of regulations holding back equity crowdfunding.”
This should bother everyone who wants the “little guy” to at least have the ability to get a bigger share of the metaphorical pie. This explains why Republicans and Democrats in the bluest of states have come together to enable equity crowdfunding for their residents.
Because the federal securities laws written in the 1930s only apply to “interstate commerce,” states can write their own rules regarding “intrastate” equity crowdfunding. And intrastate crowdfunding exemptions are being enacted in state legislatures at a similar pace as marijuana legalization initiatives and “right to try” legislation legalizing experimental drugs for the terminally ill (kudos to the Goldwater Institute for spearheading the latter initiative).
As of the end of this year, more than half of U.S. states have implemented some form of intrastate equity crowdfunding reform. According to crowdfunding activist Anthony Zeoli, the number as of December 2015 is now 30 states, plus the District of Columbia.
The blue states of Illinois and New Jersey joined red states such as Georgia and Texas in enacting crowdfunding statutes. In fact, the strongly Democratic Illinois legislature enacted unanimously one of the most liberalized equity crowdfunding laws in the U.S., thanks largely to the efforts of Zeoli and the Illinois Policy Institute. Now an Illinois firm can raise up to $5 million in increments of up to $5,000 from Illinois residents, through a streamlined process that protects investors from fraud and avoids the red tape of federal laws like Sarbanes-Oxley and Dodd-Frank.
There was also some – though not nearly enough – progress at the federal level. Three years after the bipartisan Jumpstart Our Business Startups (JOBS) Act was signed into law by President Barack Obama, the U.S. Securities and Exchange Commission (SEC) finally implemented the JOBS Act Title III crowdfunding provisions. As I have written, the SEC made some improvements from the proposed rule, such as not requiring extensive audited financial for the small firms. Nevertheless, there is still a lot of cumbersome paperwork with the 685-page rule, and $2,000-per-person cap on most individual investors, no matter their income. As SEC Commissioner Michael Piwowar stated, “even if you are Warren Buffet or Bill Gates, you are limited” in the amount you can invest.
More promising for startups is the less heralded event of Regulation A+, implemented by the SEC in the spring, also pursuant to the JOBS Act. This provision allows “mini-IPOs” to raise up to $50 million from ordinary investors in unlimited amounts. In some cases, it preempts cumbersome state rules. Though there is substantial paperwork involved, including audited financial statements in many cases, companies using this option are not subject to the wrenching mandates of Sarbanes-Oxley and Dodd-Frank. The one potential snag is that the SEC has to approve each company, so much of the rule’s effectiveness will depend on the judgment of SEC bureaucrats.
The JOBS Act’s regulatory relief, though significant, is still not enough. Entrepreneurs and investors need further relief from a JOBS Act 2.0, so true equity crowdfunding can come to fruition. Yet, even this limited relief is already spurring efforts by respected entrepreneurs.
Even before the JOBS Act provisions were implemented, the D.C. firm Fundrise found ways to enable equity crowdfunding for local real estate projects, but not without substantial red tape. Now the firm is utilizing the new Regulation A+ to offer a real estate investment trust, which the firm dubs an “e-reit,” to invest in commercial real estate properties throughout the country. Any adult can sign up directly with the company to become a shareholder with a minimum $1,000 investment. Here’s more information on the Fundrise web site.
Projects like this refute claims that equity crowdfunding will never work, because the most promising startups will simply find wealthy “accredited investors” and overlook ordinary folks. Fundrise CEO Ben Miller, who oversaw commercial real estate projects long before he co-founded Fundrise, has raised much money from accredited and institutional investors. But he is adamant that ordinary folks often have vision so-called sophisticated investors lack.
In an interview via email, Miller says:
“Institutional money is usually slow to recognize emerging neighborhoods or adopt new trends. On the other hand, the crowd is a lot faster and more nimble. Fundamentally, the crowd is generally interested in change, while the institutional investor is generally afraid of it.”
May 2016 be the year that “the crowd” and entrepreneurs serving it receive the regulatory relief they so deserve!
Mr. Berlau is senior fellow for finance and access to capital at the Competitive Enterprise Institute.