Congress Will ‘Fix’ Equity Crowdfunding

Published on April 10, 2016

By David M. Freedman

¶ Congress will—there is no doubt about it—revise Title III, the securities crowdfunding law, to make it more workable. Revisions will include raising the offering limit from $1 million to $5 million per year, reducing liability exposure for intermediaries, and permitting single-purpose funds to aggregate investors. The only question is how soon.

I’m talking about Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012, which opens up angel investing to all American investors, regardless of income or net worth.

The latest attempt to improve Title III comes from Rep. Patrick McHenry (NC), who introduced the “Fix Crowdfunding Act” on March 23, 2016. McHenry’s bill was referred to the House Committee on Financial Services. From there, who knows when or if it will be enacted into law. I hope so, soon.

Rep. Patrick McHenry (NC), vice-chair of the House Financial Services Committee
Rep. Patrick McHenry (NC), vice-chair of the House Financial Services Committee

What’s the Problem with Title III?
For one thing, when the House passed the original “crowdfunding exemption” bill in 2011, before it was folded into the JOBS Act as Title III, the raise limit—the amount of securities that companies could issue each year—was $2 million. The Senate, worried that equity crowdfunding would result in catastrophic losses and frauds, lowered the raise limit to $1 million, and that’s where Title III stood when the JOBS Act was signed into law in March 2012. A million dollars is a lot of money for some seed-stage startups, but such a limit may tend to restrict the flow of deals to the smallest, riskiest kinds of startups.

For another thing, Title III (and the SEC rules promulgated under the law) exposes intermediaries, namely funding portals and broker-dealer platforms, to possible liability if issuers commit material inaccuracies or omissions in their disclosures on crowdfunding sites. At best, intermediaries’ liability is ambiguous under Title III. Some of the largest crowdfunding companies, including Indiegogo (the rewards-based crowdfunding platform) and EarlyShares (a Regulation D equity offering platform), have expressed reluctance to venture into Title III offerings because of liability issues.

A third problem with Title III: it currently prohibits aggregating investors into single-purpose funds, or SPFs. If SPFs were allowed, dozens or hundreds or thousands of investors would invest in the SPF, typically a limited liability company set up by the intermediary, and the SPF would then invest directly in the issuer. So the direct investor is a single entity, and the issuer’s capitalization table (a sophisticated list of investors and their holdings) doesn’t become “cluttered.” Some growth-oriented startups might avoid Title III crowdfunding if they expect to raise venture capital in the distant future, as VC firms don’t like cluttered cap tables.

Legislative Proposals to Amend Title III
In April 2014, Rep. McHenry proposed the Equity Crowdfunding Improvement Act, which would have lifted the raise limit to $5 million and permitted SPFs, among other revisions of Title III. But the bill languished in committee and went nowhere.

In March 2016, McHenry introduced the Fix Crowdfunding Act (H.R. 4855), which again attempts to lift the raise limit to $5 million, relieve intermediaries of liability (for mistakes made by issuers) to some extent, and allow single-purpose funds.

Sara Hanks, CEO, CrowdCheck
Sara Hanks, CEO, CrowdCheck

“I think some wordsmithing may be in order for this bill to achieve its objectives,” says Sara Hanks, a securities lawyer and CEO of CrowdCheck, a Virginia-based due diligence and compliance firm. “However, it’s now April and I wouldn’t bet on this making it through the Senate before the [November] elections.”

The JOBS Act was enacted in 2012 with overwhelmingly bipartisan support in Congress. For the sake of tens of thousands of entrepreneurs and tens of millions of “new” angel investors, and the jobs that might be created when the latter have a chance to fund the former, we hope Congress “fixes” Title III soon, if indeed it needs fixing.

After May 16, 2016, we will see how well Title III works in its current form, and if it really does needs fixing.

Update June 1, 2016: See “Is This the Proposal That Could Save Crowdfunding,” by Jeremy Quittner, published today in Fortune.com.

David M. FreedmanEquity Crowdfunding for Investors (Wiley & Sons 2015) has worked as a financial and legal journalist since 1978. He often serves as a moderator of Financial Poise webinars for investors, and is a coauthor of Equity Crowdfunding for Investors: A Guide to Risks, Rewards, Regulations, Funding Portals, Due Diligence, and Deal Terms (Wiley & Sons, 2015). Freedman is also the editor of GreatLakesBasin.com.

Categories: Laws & Regulations

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