By Piper Kujac
Since the crowdfunding bill, officially called the HR-2930 Entrepreneur Access to Capital Act, was accepted by the House on November 2nd, and is expected to pass in the Senate any day now, we’re all wondering what this really means for small business fundraising. Is this the access to fundraising start-ups need from the SEC? With sites like Kickstarter, Kiva, IndieGoGo, and Rockethub, does the new act really matter?
As it stands, individuals who wish to fund their bright ideas may do so by collecting “donations” in the form of crowdsourcing, but they cannot sell stock or other securities to their benefactors through social media. In the 1930s, the Securities and Exchange Commission prohibited organizations from “general solicitation” for funding without a substantive relationship with accredited investors. Therefore, social media sites, such as Twitter and Facebook, cannot currently be used to reach people for funding unless the solicitation takes place in the form of a direct message. Third-party social media sites must be registered with the SEC as an official “broker-dealer” before users can legally accept transaction-based compensation or offer securities sales or stock in the company.
The Entrepreneur Act proposes that these commonplace crowdsourcing sites may now be used to solicit funding up to a $2M cap, with a max $10K allowed per investor (or 10 percent of the investor’s income). This vastly increases the potential of small startup businesses, as well as established businesses, to secure funding from individual and even anonymous investors through social media sites, when they otherwise may not be able to with a traditional bank.
There are certain downsides to crowdfunding for startups, however. Under state law, minority stockholders have certain rights, such as voting rights, and may inspect a company’s books and records, as well as bring claims against a company they invest in. Having a large number of people invest insignificant amounts into a company, and earn stockholder rights in that company, is a potential administrative nightmare as well as time-consuming and costly. Additionally, crowdfunding may deter traditional VCs from investing in a company if they see hundreds of non-SEC registered investor/stockholders. These same VCs may not want to sit on the board of directors of a company that has hundreds of other investors and stockholders, due to liability and risks of lawsuits. Likewise, D&O liability insurance rates could skyrocket for these companies.
That said, it takes money to start and run a business, and in today’s economy securing a loan is difficult, if not impossible, for most would-be startups. At this point, the proposed law has Obama’s support, and some version of it is expected to be passed by the Senate in the coming weeks. This will significantly improve small businesses’ ability to raise funds and grow their business, but not without significant risks.