- 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Consumer Price Index for all Urban Consumers, so they can be adjusted over time (this prevents the caps from becoming outdated.)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.”
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;
‘‘(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.