“Going public” now costs a company about $2.5 million. This money is spent on lawyers, accountants, and other expenses to meet the registration requirements of the Securities Act. Moreover, it costs more than $1 million annually to remain public. Any company issuing stock is subject to these burdensome requirements unless an exemption applies.
Title III of the 2012 Jumpstart Our Business Startups (JOBS) Act provides a new crowdfunding exemption to these registration requirements. The crowdfunding exception will allow entrepreneurs to raise, subject to substantial regulation, up to $1 million a year in small increments from ordinary investors through a registered funding portal via the Internet. State “Blue Sky” securities laws regarding registration and qualification are preempted. A year late, the Securities and Exchange Commission (SEC) has proposed rules to implement crowdfunding.
Crowdfunding has the potential to substantially improve small firms’ access to capital provided that the regulatory framework adopted by the SEC does not impose prohibitive costs on either issuers or funding portals. It will also enable ordinary investors to have access to investments in start-up companies that ordinarily only accredited investors have access to. Accredited investors are institutions and individuals with incomes of $200,000 ($300,000 joint) or more or a net worth (excluding their residence) of $1 million or more.
Firms using crowdfunding will almost invariably be the smallest of small businesses. More established firms or those seeking more than $1 million will use Regulation D or, perhaps, the new Regulation A+ once it is implemented. If the SEC overregulates crowdfunding, it will frustrate the bipartisan intention of Congress and the President and impede both the ability of small firms to raise the capital they need to create jobs, innovate, and contribute to the prosperity of the country and the ability of small investors to invest in the firms with the most potential growth.
This is no idle possibility. The history of the statutory small issues exemption that led to Regulation A demonstrates that overregulation can destroy the usefulness of an exemption. Regulation A as currently constituted is seldom used. It is simply too costly. The JOBS Act may improve that with Regulation A+.
The SEC is under an obligation to honor the intent of lawmakers and make crowdfunding work for entrepreneurs and the investing public. Those urging the SEC to adopt a “heavy” regulation approach are the same people who opposed the JOBS Act in general and crowdfunding in particular. Their agenda is not to make crowdfunding work but to kill it. They are seeking to accomplish this through the regulatory process what they could not accomplish in Congress. The SEC should not let itself be their means to achieve this goal.
The SEC staff is underestimating the costs imposed by the proposed rule and by the statute. The SEC estimates that the total burden to prepare and file the Form C that a crowdfunding issuer must file, including any amendment to disclose any material change, would be approximately 60 hours. Thus, the SEC appears to believe that an ordinary small business with no familiarity with regulation crowdfunding can assign one person for one-and-a-half weeks to the task of completing its offering documents and actually get the job done. Only in the case of true start-ups with no operating history is this an even mildy plausible estimate.
Even the SEC’s own figures, however, put the crowdfunding compliance costs (including the cost of lawyers, accountants, filing fees, and so on) at 20 percent to 50 percent of the amount raised for offerings of less than $100,000, about 15 percent for those between $100,000 and $500,000, and 11 percent–12 percent for offerings between $500,000 and the $1 million annual cap. This makes crowdfunding a very expensive way to raise money and will limit its usefulness.
Thus, it is imperative that the SEC hold down compliance costs. If it does not, crowdfunding will not have a chance to even get off the ground, let alone reach its potential. The rule as proposed simply imposes too many costs and must be improved if crowdfunding is to be a success.
To read detailed comments submitted by the author on February 3 to the SEC about how to reduce the regulatory burden on crowdfunding, click here. To read public comments on the proposed rule, click here.
