SSM OP-ED: SEC has a lot to get right if equity crowdfunding is to take off

By Deepali Nigam | Smash Street Media

By Deepali Nigam | Smash Street Media

The JOBS Act was passed in April 2012 by President Obama. Title III of the act promised to introduce equity crowdfunding to US shores. Title III essentially provides an exemption from registration requirements for public offerings under the Securities Act, which will allow issuers to raise up to $1 million/year from “the crowd” via online intermediaries such as registered broker dealers or an Internet Funding Platform (registered with FINRA). While crowdfunding, issuers will still be able to simultaneously raise money from other sources. 

The SEC released the proposed crowdfunding rules on Oct 23, 2013. The comment period for the proposed rules is now over and the SEC is busy finalizing the rules which are expected to be out in third quarter of 2014 but this could even drag into 2015. Proponents of crowdfunding now wait with baited breath to see what will actually come to pass. If the final rules are too close to their current proposed version, it could result in the suffocation of the equity crowdfunding market before it has even been given a real chance to survive.

Bank lending to small businesses has been steadily shrinking since 2008, and companies looking for funds have had to increasingly look to alternative means. This new means of finance promises to bring a much needed respite to small business. With 65% of new jobs coming from small businesses and 99% of the US economy made up of small business, it is in the interest of all to give the right start so it may develop into a robust marketplace.

However, the way the proposed rules are currently drafted it makes it unfeasible for issuers to even consider raising funds through crowdfunding because of the sheer cost of capital to the issuer.  If equity crowdfunding is to have any chance at all, then the SEC should be working very hard to making it cheaper for an issuer to raise funds. Currently it is particularly expensive for those conducting smaller raises of less than $500,000.  Cost of capital to these small issuers with a five-year exit plan could range from 112% to 65% for raises ranging from $50,000 to $250,000 as TABB Group research found in their US Crowdfunding: The Making of a Market report.  Those trying to raise larger amounts fare little better than other forms of finance with cost of capital for a million dollar raise being around 34%.  With such a high cost of capital, issuers will look for other more competitive forms of finance and there will be little demand for raising money through crowdfunding.

The bulk of the cost comes from the tiering system used by the SEC where those raising more have more onerous financial reporting responsibilities. Currently those raising between $500,000 to $1 million must submit yearly audited financials. For those raising $100,000 to $ 500,000, CPA certified financials are required, and for those raising under $100,000, the financial statements must be sworn to by the CEO. The audited financials add as much $26,000 to the cost of an issuer without any guarantee that they may even succeed in raising the full target amount. If the target amount is not reached then the issuer cannot keep any of the funds raised and would be out of pocket making crowdfunding a very risky proposition indeed. 

While investor protection should rank high on the SEC’s priorities, in its current form the rules are not conducive to the creation and growth of this market. It is imperative that the cost of conducting a crowdfunding raise must be lowered by the SEC in the final rules if equity crowdfunding is to have any real chance at all.