Crowd funding waits on SEC
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Crowd funding -- soliciting cash from family, friends and fans -- has raised money for victims of Superstorm Sandy and the Colorado theater shooting. It's helped budding artists produce CDs, films and games. One woman used it to raise more than $2,000 to send herself to clown school in Paris, reports gofundme.com, which helps individuals crowd fund.
Soon, small entrepreneurs who are frustrated by their inability to get bank loans will be able to raise capital by selling stock and debt to family, friends, customers and the general public. But first, the Securities and Exchange Commission must come up with rules implementing the Jumpstart Our Business Startups -- or JOBS -- Act. Congress overwhelmingly approved the legislation in April in an effort to give the anemic U.S. recovery a boost.
The rules can't come soon enough for crowd funding's advocates, who vow the concept will revolutionize banking and finance for small businesses.
"I think there's a huge opportunity here," said Candace Klein, founder of SoMoLend.
The Cincinnati venture helps small businesses get financing from family members, friends, customers and banks that have been reluctant to lend to small businesses since the 2008 credit crisis. Ms. Klein said since it was launched in 2011, SoMoLend -- short for social, mobile lending -- has provided $5 million in funding to several hundred small businesses. Each loan has supported five to 10 jobs, she said.
Currently, only accredited investors who meet income and net worth requirements and people who have a direct relationship with the borrower invest through SoMoLend. Once crowd funding rules are in place, the general public will be able to invest.
The enthusiasm of Ms. Klein and other crowd funding boosters is tempered by state securities regulators who fear crowd funding will lead to an increase in fraud because it makes it possible for the unsophisticated to invest in risky businesses without proper safeguards.
"You've got to have some sort of investment protection to make sure they're not duped," said Arkansas Securities Commissioner Heath Abshure, who is also president of the North American Securities Administrators Association.
The group -- which represents U.S. state securities regulators and their counterparts in Canada, Mexico, Puerto Rico and the U.S. Virgin Islands -- has organized a task force targeting the Internet fraud regulators expect as a result of the JOBS Act.
The law also loosens reporting requirements for small public companies and gives companies more flexibility in advertising their securities offerings to institutional investors, as well as accredited investors, individuals who meet income and net worth requirements established by the SEC.
With crowd funding, businesses will be able to raise up to $1 million annually by soliciting the general public. Investors will either buy stock, giving them an ownership stake in the venture, or provide loans. Depending on their income and net worth, individuals can invest up to $10,000 annually to crowd-funded ventures.
Crowd funding can only be done through two groups: broker dealers, who buy and sell securities for clients and their own accounts; and funding portals, which post crowd funding opportunities on their websites but do not give investment advice, solicit investors or handle their money.
Sherwood Neiss of Crowdfund Capital Advisors -- a Miami firm that advises professional investors, entrepreneurs and funding portals -- said there are plenty of protections for investors. Brokers dealers and funding portals are required to perform background checks on entrepreneurs trying to raise money. They also must educate investors so they realize the risks of funding small businesses. And entrepreneurs will have to present a business plan that convinces small investors to fund them, he said.
"This isn't about easy capital; it's about smart capital," Mr. Neiss said. "No ideas that the crowd doesn't believe in get funded."
The SEC rules will clarify what kind of disclosures investors will receive, how education will be provided and how broker dealers and funding portals will be paid for their work. They could get a percentage of the money they help raise as well as fees for other services.
Small business that have been unable to get bank financing since the credit crunch hit in 2008 are expected to be one of the biggest beneficiaries. In traditional securities markets, businesses raise far more capital through debt than by issuing stock. Ms. Klein expects that also will be the case with crowd funding. Providing loans gives investors a way to get out of their investment once the loan is paid off. They could have a harder time cashing out of an investment if they had to find a buyer for their shares in a dry cleaner, retail shop or other small business.
"You're average restaurant is not a good equity investment," Ms. Klein said.
Selling stock to small investors also could make it harder to raise large sums of money capital-intensive business such as biomedical startups require, said Catherine Mott, founder of BlueTree Allied Angels, a Wexford-based network of angel investors who back startup ventures. If entrepreneurs who rely on crowd funding give away too much stock or put too high of a price tag on their company, they will scare away angel investors and venture capitalists who can provide the more substantial financing the business needs to survive and grow, she said,
Moreover, many small business owners won't be able to manage dozens of small investors telling them how to run their business, said Joe Bartlett, a New York attorney who represents venture capitalists and angel investors.
"Who wants 100 investors? How are you going to deal with them all? It's hard enough in some companies to deal with four or five," he said.
The JOBS Act required the SEC to issue rules implementing the law within 270 days. That deadline has come and gone, upsetting some crowd funders. Their frustration was echoed last week by a key lawmaker.
"The JOBS Act is key to creating a healthier economy, yet the SEC appears to be slow-walking its implementation," said House Financial Services Committee chairman Jeb Hensarling, R-Texas.
But Ms. Klein said it was unreasonable to expect the SEC to develop rules for a whole new industry without increasing its funding or staff and given everything else the agency is doing. That includes writing rules for Dodd-Frank, the securities reform legislation enacted in 2010.
"I'm glad they're taking the time to get this right," she said.
She and other crowd funding supporters have met three times with agency officials, most recently Jan. 16 with new SEC Commissioner Elisse B. Walter. Ms. Klein believes the agency is almost ready to put out a draft set of rules. The public would have 90 days to comment on the proposals before the agency issued final regulations. That could happen this fall, Ms. Klein said.
Correction/Clarification: (Published January 30, 2013) SoMoLend, which helps small businesses obtain financing through crowd funding, has distributed $5 million in loans. An earlier version of this story gave an incorrect figure.
First Published January 27, 2013 12:00 am