Investing Blog

Finance Blogs » Investing » SEC impedes crowd-funding revolution

SEC impedes crowd-funding revolution

By Sheyna Steiner · Bankrate.com
Tuesday, April 9, 2013
Posted: 4 pm ET

It's been a year since the Jobs Act was passed, but rules on equity crowd funding remain elusive.

Crowd funding is essentially asking people for money to fund a project, business or charitable endeavor. As it stands now, the general population is limited to donation or reward-based crowd funding through platforms such as Kickstarter or Indiegogo. People hoping to raise money through crowd funding can give out products or prizes in exchange for donations, but not equity stakes in the business.

That is set to change. On April 5, 2012, President Barack Obama signed the Jobs Act into law and officially gave the go-ahead allowing small investors to fund startups and other projects in return for stock or equity returns in the company. After signing the act into law, the president handed off the responsibility of figuring out how it would all work to the Securities and Exchange Commission, the investing regulatory agency.

Setting up the legislative framework was the easy part. Determining how it will all work seems to be another matter.

The Securities and Exchange Commission, or SEC, has been taking public comments since the law was passed last year.

Protecting investors is important

The Jobs Act limited the annual amount an individual could invest in a crowd funding business in exchange for equity to either $2,000 or 5 percent of annual income or net worth for people with incomes or net worth less than $100,000. For investors with incomes or net worth more than $100,000, the maximum is 10 percent of annual income or net worth, with a cap of $100,000.

A common theme in public comments to the SEC has been the enforcement of the investor limits. Issuers will only be able to sell equity in their fledgling businesses through registered broker-dealers or intermediaries known as portals. Until the SEC issues proposed rules, it is unclear how the investor limits will be enforced.

The compliance burden on companies hoping to raise money through equity crowd funding is also a hurdle. One issue that attracted a lot of ire over the year since the law was passed has involved the requirement of audited financials for issuers trying to raise more than $500,000.

"My opinion is that it needs to be time as well. You could have a $500,000 raise and be in business for only a year -- so audited financials don't make sense. You have to account for the microstages in the first couple of years," says Elizabeth Smith Kulik, a founder of ProHatch.com, a crowd-funding platform.

"It is the alignment of time and space. You could be crowdfunding a $500,000 project to fund a new release that was not in the budget so crowdfunding becomes an opportunity for a project, not a start-up. There are a wide range of applications," she says.

Besides mind-boggling complexity, what are the hold ups?

Those are just two of the issues surrounding investor protection and issuer disclosure and transparency. In the Jobs Act, the SEC was given 270 days to study the issue and come up with some rules. It was nearly inevitable that they would fall short of that mark.

"The election got in the way and then the SEC chairwoman stepped down. It's an important act and a considerable undertaking to change the SEC code that hasn't been changed since 1933 or 1934," says Kulik.

Crowd funding represents a whole new way of doing things, and there are many moving parts to consider.

Plus, the SEC is still implementing parts of the Dodd-Frank Act, notes Carl Esposti, CEO of Massolution, a crowd-funding research and consultancy.

"Apart from, obviously, the workload that they are under currently, crowd funding is a very different model predicated on a theme of openness, communication between social media and crowd-funding platforms, open dialogue and new consumer behaviors. It's changing how individuals engage through the Internet, enabling dialogue and participation that presents new challenges to the SEC," he says.

Figuring out how to protect investors from fraud -- and from themselves -- under the new model will take a little time.

Crowd funding now

Despite the limitations on equity crowd funding, the industry continues to gather steam; in 2012, crowd funding raised $2.7 billion compared to $1.5 billion in 2011, according to a report released Monday by Massolution, 2013CF: The crowd-funding industry report.

According to Massolution research director Kevin Berg Grell, the number of campaigns did not increase exponentially -- but the amount of money individual campaigns are able to raise did increase.

Until the rules on equity crowd funding shake out, there are three types: donation-, reward- and lending-based.

Lending-based crowdfunding gained traction in 2012, with 111 percent growth, says Grell.

"Lending-based crowd funding spans anything from personal loans to crowd-funded microfinance to small business loans. One of the developments you see is community-based crowd funding. People can go online and support companies they have in their local community," he says.

That's legal in some states but not all of them -- "Louisiana being one of them. Rebirth Financial is allowed to host offerings from companies in Louisiana if the crowd is in Louisiana," Grell says.

Once the rules from the SEC are in place, the federal law will preempt various state laws.

What's really exciting are the myriad ways crowdfunding can work. It's much more than a way for charitable strangers to donate to a good cause or funding your ice cream stand / electric car company / hemp clothing store.

"We're starting to see crowd funding move beyond campaign level. Institutions are looking at how they can implement crowdfunding at a national level. Larger enterprises are looking at how crowdfunding can be used to test product ideas, community and employee engagement," says Esposti.

"It is going to restructure traditional capital flows and how businesses engage with their marketplaces. Everything is undergoing a total disruption," he says.

As an investor, I'm not totally convinced I would invest through crowd funding. I'm not ruling it out, but the potential for bringing communities together interests me more. What do you think?

Follow me on Twitter: @SheynaSteiner

***
Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

«
»
Bankrate wants to hear from you and encourages comments. We ask that you stay on topic, respect other people's opinions, and avoid profanity, offensive statements, and illegal content. Please keep in mind that we reserve the right to (but are not obligated to) edit or delete your comments. Please avoid posting private or confidential information, and also keep in mind that anything you post may be disclosed, published, transmitted or reused.

By submitting a post, you agree to be bound by Bankrate's terms of use. Please refer to Bankrate's privacy policy for more information regarding Bankrate's privacy practices.
4 Comments
Lance
April 11, 2013 at 5:41 pm

This act is very interesting. However, the caps could prove to be too strong and bring crowdfunding down. It really limits what companies like iCrowd will be able to do in order to help fund start up companies.

Kaitlyn Coiner
April 10, 2013 at 4:17 pm

That sounds like a great idea!

Rosana Francescato
April 10, 2013 at 1:25 pm

While I look forward to implementation of the JOBS Act, I already do something similar that's not bound by the JOBS Act -- I invest in solar projects through joinmosaic.com. I'd call it crowd "investing" more than "crowdfunding" but it's a similar idea -- Mosaic's investors loan money to solar project developers and get paid back with interest -- it's like LendingClub for solar. I'm earning 4.5% annually on my first 3 investments -- not bad!