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The Pioneers of Title III Equity Crowdfunding

The SEC announced Monday that it will vote Oct. 30 on final rules for Title III equity crowdfunding. If the rules are approved as expected, they will go into effect at the end of the year. Then tens of millions of non-accredited investors (people whose net worth is less than $1 million or whose yearly income is under $200,000) will be allowed to invest in startups and early-stage companies via crowdfunding portals and broker-dealer websites.

This is good news for the entrepreneurs, “retail” investors, and intermediaries (portals and broker-dealers) who have been exasperated by the SEC’s delay in issuing final rules. We want to give credit to the people who brainstormed the “equity crowdfunding exemption” and escorted it through the legislative process.

Ups and Downs of Equity Crowdfunding

After the dot-com bust in 2000, venture capital investment by accredited investors fell off dramatically. There was a perception that startups did not have adequate access to available capital, particularly through online capital raising; and that small investors did not have access to early-stage investment opportunities. The idea for “crowdsourced securities offerings” in which all investors could participate arose in the USA around 2007, and a year earlier in Australia.

Based on the success of Kickstarter and Indiegogo, the idea for legalizing equity crowdfunding gained momentum in 2009 among a handful of entrepreneurs and lawyers. Paul Spinrad, a projects editor for MAKE magazine (and now the founder of Subramp.com), may have been the first to post the idea on a public forum, namely the blog BoingBoing. He was joined by a lawyer named Jenny Kassan, director of a community-supported entrepreneurship program at the Sustainable Economies Law Center; and Danae Ringelmann, founder of IndieGoGo, who developed the idea further.

Subsequently a trio of entrepreneurs and graduates of the Thunderbird School of Global Management in Arizona—Sherwood Neiss, Jason Best, and Zak Cassady-Dorion—decided to codify the idea and take it to Congress. They had been leaders in companies that had raised millions of dollars from traditional angel investors and venture capital firms, and had built successful businesses.

“We were frustrated that, at the depths of the financial crisis, you could give away money on rewards-based crowdfunding sites, and you could lend money to entrepreneurs in the developing world on sites like Kiva.org, but most people were not allowed to invest in businesses that they used every day, or in entrepreneurs whom they believed in,” says Best, who is now a principal in Crowdfund Capital Advisors. The trio gathered around a kitchen table one night and wrote the first draft of what they called the Startup Exemption Crowdfunding Framework. (See the original Framework www.startupexemption.com.)  This 10-point framework became the basis of the Crowdfunding Act and then Title III of the Jumpstart Our Business Startups (JOBS) Act. They self-funded their campaign to lobby the White House, the House of Representatives, the Senate, and the SEC for its adoption into law, working closely with Karen Kerrigan, CEO of the Small Business and Entrepreneurship Council, the lobbying group for small business in Washington, DC. Other organizations lobbied independently for an equity crowdfunding law, including the American Sustainable Business Council and the Cambridge Innovation Center.

The JOBS Act passed was enacted in March 2012 with strong bipartisan support in Congress. The act combines seven substantive parts, Title I through Title VII. The first six of those were derived from six separate pieces of legislation. For example, what started as the Crowdfunding Act, debated in both the House and of Representatives and the Senate in 2011, was later folded into the JOBS Act as Title III.

Title III legalizes the offering of up to $1 million in equity by private startups and small businesses to all investors, regardless of net worth or income. All investors will be able to invest at least $2,000 per year and up to $100,000 per year in angel deals, depending on their net worth or income. Congress specified that Title II through VI would go into effect only after the SEC issued rules that would implement these parts of the law (although part of Title V is self-executing). In the case of Title III, that did not happen for more than three years.

Transformation of Crowdfunding Landscape

Duncan Niederauer, CEO of NYSE Euronext (a merger of the New York Stock Exchange and Euronext NV), predicted that equity crowdfunding, if properly done, “will become the future of how most small businesses are going to be financed.”

Even Mary Jo White, the SEC chair since April 2013, said that thanks to the JOBS Act, “…we are at the start of what promises to be a period of transformative change in capital formation.” What makes this statement interesting is that previous SEC chairs were believed to be averse, or at best indifferent, to the idea of equity crowdfunding. We shall soon see how transformative it really is.
— David M. Freedman has worked as a financial and legal journalist since 1978. Matthew R. Nutting is a corporate lawyer with the firm Coleman Horowitt in Fresno, CA. Freedman and Nutting are coauthors of “Equity Crowdfunding for Investors: A Guide to Risks, Rewards, Regulations, Funding Portals, Due Diligence, and Deal Terms” (Wiley & Sons, June 2015).

About David M. Freedman

David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…

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