US House Passes Important Crowdfunding Legislation

The U.S. House overwhelmingly passed its first significant crowdfunding legislation, allowing entrepreneurs to crowdsource up to $2 million per year.

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US House Passes Important Crowdfunding Legislation

by Jeff Steele

UPDATES:

  • 8 DEC 2011: The Senate introduced S.1970 (a bill to amend the securities laws to provide for registration exemptions for certain crowdfunded securities) and referred it to the Committee on Banking.

The U.S. House overwhelmingly passed its first significant crowdfunding legislation, in the form of H.R. 2930, the Entrepreneur Access to Capital Act.  The bill (now in the Senate) amends the Securities Act of 1933, by allowing entrepreneurs to crowdsource (online) up to $2 million per year in investment capital directly from individuals without having to register the investors with the SEC; however, the commencement and completion of the raise do need to be filed with the SEC.  Entrepreneurs (the “issuers”) must provide potential investors with audited financial statements in order to qualify for the $2 million cap, otherwise you are capped at $1 million.  Individual investments from crowd-shareholders are capped at $10,000 (or 10% of their annual income), whichever is less.

To be clear, this is not free money; these are bona fide investor-securities for which they will receive a return on their investment as well as ownership interest in your enterprise, be it film, music, games, art, books, inventions, startups, etc.

Many filmmakers have raised funding for films on popular gifting sites like Kickstarter and IndyGoGo. These sites have found success raising free money for ultra low budget films and other projects through crowdfunding models where people can pledge as little as $1 and as much as they like to a variety of different projects; that is free gift-money that cannot be paid back, so project benefactors have no financial interest in your film, nor can they take a charitable deduction on their gift (though some sites have contrived charitable workarounds.)

H.R. 2930 specifically amends the “Requirements with Respect to Certain Small Transactions” (Section 4A of the Securities Act), by providing for registration exemptions for certain crowdfunded securities — the details of which are summarized at the end of this article.

Some important points worth highlighting are:

  • the $1m/$2m funding caps and the $10,000 investment cap are pegged to the Consumer Price Index for all Urban Consumers, so they can be adjusted over time (this prevents the caps from becoming outdated.)
  • a requirement that the issuer or broker use a 3rd party for cash management (this keeps prying fingers out of the cookie jar.)
  • a requirement that the issuer or broker raise at least 60% of the target offering to take possession of the funds (this is a good because it keeps the issuer from collecting money for a project they can’t afford to finish.)
  • that raising crowdfunds does not preclude issuer from raising capital by other means (this allows crowdsourced equity to participate in traditional capital structures alongside (other equity investors, tax credits, collateralized and mezzanine loans, etc.)
  • background checks are required for issuers and brokers/intermediaries.
  • that crowdfunded shares cannot be resold for 1 year, unless the shareholder is an accredited investor or the issuer.
  • the Act does not specify which enterprises can be crowdfunded and which enterprises will be banned, if any.  So that remains to be seen.
  • the Act does preempt state “blue-sky” laws, but still allows for state enforcement.
  • Massachusetts has the most representatives that voted against it (5 out of 10). Curious.
  • the initial funding cap was $5 million, but was quickly lowered to $2m/$1m.
  • the Act spells crowdfunding as one word, which will hopefully alleviate the 1 word vs. 2 words vs. hyphenated discrepancies.

The bill has met some backlash by politicians claiming that crowdfunding measures would lead to speculative, risky offerings that could translate into heavy losses for small investors.  This argument has merit and should be carefully considered by the Senate and SEC.  It’s ironic that given the potential fraud risk and rampant financial abuses of the past 10 years that the House Republicans voted (in a strict partly-line vote) to kill an amendment that would have required intermediaries to disclose to potential investors how they are compensated.  This issue has plagued charities that outsource fundraising to 3rd party companies that, in turn, take a hefty percentage of the donations they raise.  Perhaps the Senate will re-introduce it.

During the Senate Banking Committee’s December 1st hearing on spurring job creation through access to capital, Senate Banking Committee Chairman Tim Johnson said in his opening statement that they will hear from witnesses who will “provide insight on proposals to expand the scope of Regulation A offerings, to permit general solicitation of investors in Regulation D offerings, and to allow individuals to solicit and sell small amounts of stock over the Internet through crowd-funding.”

Johnson continued, “They will address the size of a private offering and the amount of money that a crowdfunder should be able to risk without full regulatory protection.  They will discuss the types of markets where these securities should trade. They will also describe the existing investors’ safeguards, such as disclosures about the business and financials, and how current proposals would affect those safeguards.”

Summary of H.R. 2930 (PDF):

The amendments to Section 4A are as follows:
‘‘(6) transactions involving the offer or sale of securities by an issuer, provided that—

‘‘(A) the aggregate amount sold within the previous 12-month period in reliance upon this exemption is—

‘‘(i) $1,000,000, as such amount is adjusted by the Commission to reflect the annual change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics, or less;

or

‘‘(ii) if the issuer provides potential investors with audited financial statements, $2,000,000, as such amount is adjusted by the Commission to reflect the annual change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics, or less;

‘‘(B) the aggregate amount sold to any investor in reliance on this exemption within the previous 12-month period does not exceed the lesser of—

‘‘(i) $10,000, as such amount is adjusted by the Commission to reflect the annual change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics; and

‘‘(ii) 10 percent of such investor’s annual income;

‘‘(C) in the case of a transaction involving an intermediary between the issuer and the investor, such intermediary complies with the requirements under section 4A(a); and

‘‘(D) in the case of a transaction not involving an intermediary between the issuer and the investor, the issuer complies with the requirements under section 4A(b).’’

H.R. 2930 goes on to describe the statutory Requirements to Qualify for Crowdfunding Exemption, for issuers and brokers, which includes cautionary language, background checks, website requirements, etc.

  • Scott Hillman

    Intresting. As some one trying crowdfunding for the first time its an enlightening experience. Life is intresting.

    The law however does ignore whats perhaps the werid grey area of any crowdfunding-where does equity financing end and crowd funding begin. This isn’t a point of ficiousness. If i for example donate 1 dollar to a movie and then me and in the owner talk about the project, have i done the necessary contact to mean that we can now invest normally in the film(security investment is all about cold calling)-on the flip side if my mother invests in my movie(which is perfectly valid equity investor) invest in my crowdsharing campaign is she subject to these requirments.

    Of course theres an element of these kind of principals of any kind of secuirty laws. There is just an element that the smaller you get in security principals, to a certain extent the siller to a degree it becomes. The fundemtal purpose of these kind of laws is that a shiester can’t steal his grandmothers life savings through a kickstarter campaign. However its already pretty legal to do it anyway.

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  • Scott Hillman

    How this will change the indie film world beyond what the kickstarters of the world are doing? Donno. As someone who has spent a bit of time browsing his ahem competition in the world of indie funded film projects(and for the record i am working more on demo for a larger project), i keep thinking-

    how are any of these movies going to get distribution? and ergo make money.

    I don’t begrudge these kind of films from existing, or people paying money to make them-art for art sake. However there still a madness to hopping they do make money, that i find a hard time shaking. Well will see.

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    • Jeff Steele

      The main reason that no film project has raised more than $1 million on gifting-sites like kickstarter and indiegogo is that there’s no return on investment. It takes a lot of people willing to part with a lot of cash. For film to raise in excess of $1m via HR-2930, it will need to be commercial to have a realistic chance of returning the investment.

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      • http://www.indiegogo.com/Spinnerette Scott Hillman

        But that present a kind of seperate challenge. How do you do that? I remember the company a couple of years ago that did go to the trouble to register, have shares and get a prospectus(i could look it up but i am not going to).

        The problem with it was that it was clearly trying to sell the kind of movie that would normally would be prepackaged. It was a rommantic comedy. Didn’t have any stars in a genre built on stars. Didn’t have a director, though perhaps thats not as important for a mid grade romcom. The script wasn’t bad -but kind of generic. The only thing that i remember firmly about it was that it was clearly aiming for an R.

        In terms of it making money, yes i could imagine it doing that. however as a movie investment- I don’t want to be that european presale agent who is only intrested in Johny Depp but…

        You have written extensivly of getting stars to a project-but a kickstarter one? What if it doesn’t work,if when push comes to shove people aren’t willing to personally fork up Tom Cruises sallary. I know Colin Hanks who is kind of around the C list did a kickstarter movie about a year ago, but it was also for like 50k

        Theres also the ellement of Surprise-you making the script availbe? Prehype a project years ahead of its coming out(something that distributors tend to be pretty wary of)? What do you actually give strangers to tell about your movie. I have never been the NDA kind of guy,but seriously.

        Which is to say i can imagine a Million Dollar Campaign working, which i supose using your principal could makes a 2 or 3 million dollar actual movie with presales and tax credits… But the legality is only the first trick. Agian to the film project that sought investors, clearly a lot of thought and effort had went into the IPO-however what they actually where doing, not so much.

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        • http://www.google.com/ Butterfly

          You’re on top of the game. Thanks for sahrnig.

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      • http://www.bing.com/ Philinda

        What a joy to find someone else who thkins this way.

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  • http://www.indiegogo.com/Spinnerette Scott Hillman

    And in shamless comerce heres a link to my Indiegogo campaign:

    http://www.indiegogo.com/Spinnerette

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  • http://sokap.com david geertz

    Thanks for keeping us all in the loop Jeff. You’ve been following this since Paul Spinrad and the guys thought the idea for changing the rules was a good idea.

    There have been a lot of people who have helped push this through and it will be an interesting 18-24 months as we all see what happens.

    Distribution has not been a problem for several years now; however, marketing has been and will continue to be the ‘next’ missing piece of the puzzle.

    Thanks

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    • Jeff Steele

      Thanks Dave. Filmmakers and entrepreneurs need to raise production and distribution money. They can do $1m + $1m, or somebody else can raise a $2m+ P&A fund.

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  • http://michaelrbarnard.wordpress.com Michael R. Barnard

    Thanks for a another great article, Jeff.

    It is significant that this is possibly the most bi-partisan effort of this era, supported by Obama, the Democrats, the Republicans, and even tax-payer groups. It will not have any measurable cost to taxpayers.

    I believe thid could be the most significant boost to the independent film industry since digital cinematography. One million dollars has been considered to be today’s “sweet spot” for competitive production values. Unfortunately for our infrastructure, that target budget is usually achieved with volunteer labor, borrowed minimal equipment, and gifts. This ability to raise real funds for real budgets will result in rebuilding the infrastructure of the indie film biz.

    Of course, this is important news for the “ROI” filmmakers rather than the hobbyist filmmakers. It will require the skills, details and commitment of those filmmakers knowledgable about Return on Investment, breakdown and scheduling, budgeting, cash flow forecast, comparables, distribution channels and windows, and production disciplines. These are all skills producers used to be presumed to have until the current malaise destroyed hope for ROI.

    This is new hope for rebuilding the indepent film business infrastructure. Every filmmaker should write their senators and tell them to support the act and assure inclusion of filmmaking. It is very possible we could get excluded if we do not raise our voices.

    The biggest threat against the ENTREPRENEUR ACCESS TO CAPITAL ACT is the boogie-man issue of fraud. First, fraud is a function of bigger money (Madoff and his ilk always exist and seek huge dollars). Second, fraud is mostly based on the greed of investors, easily exploited by evil people (caps per investor make this less attractive). Third, crowdfunding has proven people DESIRE the opportunity to participate in filmmaking even when aware that there will be NO return (crowdfunding growth has been explosive). Fourth, unreasinable fear…

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  • BenL

    Thank you Jeff. This is a very exciting time. I will be following this as it moves through congress. It will be very interesting to see what happens in the marketplace.

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  • Andy Halmay

    A very interesting development that brings up new questions. I’m amazed by the fact that real funds have been raised by sometimes silly projects through the Kickstarters, etc. Personally, I feel uncomfortable taking gift funds. It feels like charity. Going legit for up to $2 million feels much better. $2 million cash can be stretched to $2.6 or more through tax rebates in production, etc. But how to market the units??? The crowdfunders have a presence and an audience but could they go both ways? I don’t think so. Individual producers selling shares directly to investors would start from scratch each time, setting up their own website, etc. Someone will need to set up an online brokerage of sorts if there is a legal way to do so. With the cap on the size of the investment unit at $10,000, you need 200 investors. As someone pointed out, independence may be achieved by doing a separate underwriting for P&A. Since this is for the same project, the equity offered would somehow have to be combined. Much to think about!

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  • http://michaelrbarnard.wordpress.com Michael R. Barnard

    (argh… too many words, once again. Forgive typos, plase; I tapped this out on my phone’s virtual keypad. Continued:)

    Fourth, unreasonable fear about small funding investments has crippled growth for small business (fraud should be dealt with via public education, not further reduction of opportunity.)

    It is this simple: SAVE THE INDEPENDENT FILM INDUSTRY! WRITE YOUR SENATORS!

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  • http://joeb.biz Joe Ochoa

    as a newbie, in the industry
    We have been in a different industry in the A-Pac region of the world.
    We have been studying the global film industry as it relates to cooperative efforts to bring together with joint efforts:

    $-talent-creativity-existing production to = a joint globally distributed film

    My question to you all is thus: Given interested parties of Asian, Mexican and Russia filmmakers what possible avenues exist and can be effectively joined to help our USA counterparts. We are in the process of opening a first China/Mexico distribution company in USA. Global crowdfunding? It is available.

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  • Karen Sundt

    Having been a camera and lighting gal all this investment discussion is new to me but find it quite fasinating. Trying to jump into a producer roll, I appreciate all the points that have been brought up and quite Helpful. Some of it I still have not completely digest and will have to do more research but the fact that this is being talked about is wonderful! Keep it up! And thanks to all…

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  • http://www.odethemovie.net Brian Mathew Kowalchuk

    I’ve said before that crowdfunding sets up for serious legal issues if the film starts to generate serious revenue. This new bill appears to set this prospect up even more substantially. For example, if the cap is $10k per investor on a $2M film, that means there are 200 investors. What if a film starts generating serious box office revenues and these investors aren’t seeing any return on their investment? What if the film has 2,000 investors who aren’t seeing revenue return checks in their mailboxes?
    The lawsuits will definitely start to fly.
    Hopefully the independent 3rd party money manager won’t disappear.
    Along with the bookkeeper.
    Maybe it would have been better to have left this arena alone.
    I’m just sayin’.

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    • Jeff Steele

      That’s why producers must use collection account managers (CAMs).

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  • Andy Halmay

    Brian, these will be real shares representing equity in the film. If the film does very well, the shares will have proportionate value but there will have to be a formula for redemption of shares. What this bill will do, as I read it, will give the promoter a chance to reach a wide public through the internet.

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  • Jeff Steele

    UPDATE: The Senate introduced S.1970 (a bill to amend the securities laws to provide for registration exemptions for certain crowdfunded securities) and referred it to the Committee on Banking.

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    • http://www.facebook.com/ Jaylyn

      None can doubt the veracity of this atircle.

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  • T

    So now that crowdfunding can have an ROI, what are the best online platforms to find investors?

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    • Jeff Steele

      They haven’t been built yet, nor have the details been codified. The statutes dictate some issuer and broker requirements, but it still needs to be approved by the Senate and signed by the President. Then the SEC has to draft the official Rules & Regs.

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      • http://michaelrbarnard.wordpress.com Michael R. Barnard

        Jeff, assuming the Act is similar to the current version and signed, do you happen to have a good guesstimate of the milestones and length of time before we see this in practice?

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        • Jeff Steele

          My guess…9 – 12 months.

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      • http://www.google.com/ Jonnie

        That hits the target prefectly. Thanks!

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    • http://www.bing.com/ Lorraine

      Didn’t know the forum rules allowed such brlliaint posts.

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  • http://www.yahoo.com/ Destry

    This site is like a clsasroom, except I don’t hate it. lol

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  • http://www.wuildkwest.com Vicki Slomkowski

    Thanks for all your efforts that you have put in this. Very interesting info. “When we cannot hope to win, it is an advantage to yield.” by Quintilian.

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  • Pingback: CROWDFUNDING LAW by CROWDFUNDING RESEARCH - Pearltrees

  • http://michaelrbarnard.wordpress.com Michael R. Barnard

    Here is my article about the JOBS ACT signed into law today by President Obama, and its Equity Crowdfunding provisions that could help rebuild the independent filmmaking industry.

    http://reelgrok.com/news-article.cfm?id=386&t=n

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