Real Investment Crowdfunding is Main Street–Not Goldman Sachs
When thinking about what is required to make investment crowdfunding work, I get the sense that not many people are thinking enough about what crowdfunding already is and how it got there. This is a problem as regulators are attempting to define the landscape. Maybe it is just an issue of timing, but I sense it is something more here. The timing issue is that pending regulations that the lift the general ban on solicitation are certain to occur before Title III crowdfunding regulations are promulgated. This lifting of the general ban on solicitation has an impact on investment crowdfunding, and enables crowdfunding for accredited investors, but it is certainly not limited to crowdfunding. In fact, some of the more interesting applications of the ability to generally advertise private investment opportunities have nothing to do with the Internet or social networks. After all, just imagine if Y Combinator ran its next class as a reality TV show and at the end of the reality show accredited investors could actually invest in the class of new companies? That is a pretty dramatically different world. However, creating new mechanisms for the same types of companies to get essentially the same type of funding (as to size of the round and size of an individual investment) from essentially the same type of investor, is not crowdfunding to me—it is generally advertised Reg. D investment.
To me, genuine investment crowdfunding is something very different and it has its roots in what crowdfunding as an industry already has become. Crowdfunding drew the attention of lawmakers because large amounts of money was getting contributed to help fund things that have never been privately funded before. No better example exists than Kickstarter’s funding of independent films and music. Genuine crowdfunding is more likely to occur when the Title III regulations are promulgated because Title III investments can be made by anyone who is old enough to enter into a contract. This means that people who cannot easily invest in companies now will be able to do so. It is investment for everyone.
Because anyone can invest and because Title III investments will be capped annually, both for issuers and investors, the investors and the investments are likely to be very different than what is realized by companies receiving outside investment today. A standard Series A round for a tech company will exceed the $1 million annual cap for such a company. While one can contest the propriety of the particular caps, the notion of investor caps helps create the true crowdfunding dynamic of smaller investments and larger numbers of investors. Under Title III, I think mostly about communities funding a local coffee shop as opposed to mini Fred Wilsons looking to invest in the next Twitter.
Don’t get me wrong, there will be unconventional companies funded through new rules under Title II enabled 506 rounds as well as some genuine crowdfunding rounds under Title II. There will also be some new Facebooks funded under Title III crowdfunding. However, my on unofficial survey indicates that the bulk of the crowdfunding portal industry is gearing up for Title II “crowdfunding” and is aiming for larger rounds that will not fit under Title III. For portals attempting to be as profitable as possible, that makes some sense. The problem is that if regulators are only speaking to this group, there is no one at the table discussing what is necessary to make genuine crowdfunding work and pointing out what could be accomplished if the JOBS Act concept of a funding portal is actually realized. These Internet investment bankers are not trying to make smaller offerings to companies not now being funded work. They want to be investment bankers, so the cost of being broker-dealers is not particularly significant because larger investment rounds can absorb those costs and the activities they want to conduct require registration anyway.
Hopefully the regulators are thinking of how to make equity rounds as small as $50,0000 viable through funding portals. These micro-rounds would be very enabling for many Main Street businesses because even SBA loans require some equity in the capitalization. That is what genuine crowdfunding is about. The JOBS Act was written with the understanding that this type of round cannot absorb the costs of broker-dealer compliance. Further, this type of funding cannot absorb a burdensome registration or compliance program from FINRA that could be created for funding portals. I hope these issues are getting full consideration by regulators because it really does not appear to me that crowdfunding industry groups really care about making small rounds viable. It is these small rounds that will have tremendous impact for Main Street–like new coffee shops, landscaping businesses, bakeries, organic food stands, fitness centers and florists. In a post recession world, capital is just not available for these businesses. These proprietors no longer have home equity, let alone home equity lines of credit that formerly served to get them started. This is not very interesting if you want to be an internet Goldman Sachs but the economy does not need more of that. We need new investment from new investors and this is what crowdfunding is really about. Even for tech companies, seed rounds like this can have a dramatic impact. That is one thing that Y Combinator and Techstars have already proven–$50,000 can go a long way.