November 3, 2011
I have blogged from time to time about the crowdfunding phenomenon and the possibility of using crowdfunding for small business capital formation. See, for example, here and here. I have also written an article, available here, proposing a crowdfunding exemption from federal securities law registration requirements.
Political momentum seems to be building in support of some sort of crowdfunding exemption, although what its exact features will be is still unclear. Here are some recent developments:
1. The Jobs and Competitiveness Council created by President Obama in January recently endorsed crowdfunding, at least in a very general way. The Committee’s interim report proposes that “smaller investors be allowed to use ‘crowd-funding’ platforms to invest small amounts in early-stage companies.” The Council’s full report, which provides no further details, is available here.
2. H.R. 2930, a crowdfunding bill introduced by Congressman Patrick McHenry, has been amended and reported to the full House. The amended bill is here. I’ll provide a more detailed discussion of that bill tomorrow.
3. I have been asked to speak on crowdfunding at the annual SEC Forum on Small Business Capital Formation on November 17. I’m impressed that the SEC is willing to invite a longstanding critic like me to speak; it’s like the Democratic National Committee inviting Herman Cain to present a keynote. But I’m a longtime fan of the forum itself; many sensible recommendations have come from those annual meetings, although the SEC usually fails to act on those recommendations. If you’re interested in the forum, more information is available here.
What will prevent crowdfunding's becoming a neologistic version of penny stocks? If the SEC's enforcement arm is stretched thin now, how will it police thousands of start ups that couldn't get money from knowledgeable investors?
Posted by: Arthur Armstrong | Nov 4, 2011 9:41:03 AM
Good question. As I discuss in my article, small business offerings pose a greater risk of fraud, but also a greater risk of loss in general. And, as you point out, the public investors likely to be attracted to crowdfunding generally lack financial sophistication. There will be losses. Both my proposed exemption and H.R. 2930 attempt to limit those losses to an amount investors can afford by limiting the amount of investment. Reasonable people can disagree about what the limit ought to be, but such a limitation at least prevents catastrophic individual losses. There are other limitations--transparency requirements, the use of a neutral intermediary web site, restrictions on when an issuer may close the offering--that I also think will help police issuers. But there will still be losses.
I can't accept the unstated premise of your question that most of these offerings will be bad because they "couldn't get money from knowledgeable investors." For a number of reasons, most of the usual, non-public sources of business capital--venture capital, angel investors,bank financing--aren't available to very small start-ups. I go into more detail in my article, but it's pretty clear there's a capital gap at those lower levels. Who knows how many good entrepreneurial ideas are lost because of this? (I have seen various dollar estimates of the gap, but these seem mere speculation to me.)
Therefore, the question is whether you want to impose a cost on ALL very small entrepreneurs in order to protect investors from the actions of the much smaller class of fraudulent offerings. I would prefer to emphasize fraud enforcement and just impose costs on the wrongdoers. And keep in mind that thousands of investors are already investing in non-securities business crowdfunding, just without securities being involved. The risk of fraud is the same whether or not securities are being offered. Allowing them to buy securities would give them a positive return to offset some of that risk.
Posted by: Steve Bradford | Nov 4, 2011 11:34:03 AM