By Robert Romano — Legislation that would allow stock offerings up to $1 million across state lines on the Internet to so-called “unsophisticated” investors has passed both houses of Congress, and now proceeds to the White House for President Barack Obama’s signature.
Obama has signaled he will sign H.R. 3606, the so-called JOBS Act, and so it looks like — on the surface — that Congress has suddenly decided to overturn nearly 80 years of securities laws that had previously prohibited such offerings.
This could mean that very soon, once the Securities and Exchange Commission (SEC) is through creating the rules to enforce this law, starting a new business and raising capital could be as easy as starting an account at Kickstarter.com or Indiegogo.com and selling the next big idea to potential investors.
But not so fast. While the original bill that passed the House, offered by North Carolina Republican Rep. Patrick McHenry, had been placed on the Senate’s calendar, that is not what ultimately passed.
Instead, the Senate, led in part by Massachusetts Republican Sen. Scott Brown, modified McHenry’s bill, folding it into H.R. 3606, and sent it back to the House, where it passed.
The McHenry predecessor had preempted state-by-state blue sky laws, eliminating the costly start-up filing, legal, accounting and auditing fees often associated with such offerings.
The Senate bill does that, too, but then H.R. 3606 creates a whole new federal requirement — for the very reviewed and audited financial statements once provided for under state law. This time, companies attempting to raise more than $100,000 must be reviewed by public accountants, and more than $500,000 fully audited.
What’s so bad about that? According to Goingpublic.us, the cost of direct public offerings can range anywhere from $40,000 to $100,000, or even be as high as $1 million, depending on the complexity of each transaction. The bulk of those fees are directly related to accounting and auditing requirements.
So, that means a new business seeking to raise just $500,000 in capital through crowdfunding to produce, say, video games, will have to first incur an up-front cost of tens if not hundreds of thousands of dollars in fees.
Except, businesses typically attracted to crowdfunding venues like Kickstarter and Indiegogo often do not have any capital to speak of, let alone $40,000 to $100,000 to spend on lawyers and accountants. In many cases, there will really be nothing to audit or account for. It’s a superfluous requirement.
But worse, it creates a catch-22: to raise capital on the Internet, the company first needs a pile of money to meet the regulatory requirements.
So, start-ups may be back right where they started. Thanks to Senator Brown, in his rush to regulate this new area of capital creation, he may have effectively defeated the entire purpose of the crowdfunding provision of the law. In part, it shows his ignorance of what crowdfunding even is.
A relatively new phenomenon, crowdfunding operates with small businesses raising small-dollar contributions from a large number of people, typically on the Internet. Web companies like Kickstarter.com have helped raise more than $100 million since it launched in 2009 for non-profits, low-budget film productions, video games, and other projects.
Slava Rubin, founder and CEO of Indiegogo, has said he intends to file to become a funding portal under the new law. “[W]e’ll be able offer for-profit equity investments… Small businesses need to find a way of getting capital right now,” he said in an interview with Portfolio.com.
For now, individuals who pledge money to projects are enticed with rewards upon completion, such as a DVD or the video game itself, but cannot gain a stake in the company. These projects are already being funded without any complex scheme of mandatory accounting and auditing. And despite there being no mountain of regulations, funded projects are typically completed without complaint.
“If we had a lot of fraud going on we’d be out of business,” Rubin noted.
Why Senator Brown felt the need to include such onerous and costly requirements is anyone’s guess, but they now present a challenge to crowdfunding venues that would like to cater to start-up companies that simply don’t have the money to pay for the mandatory accounting and auditing.
Here’s a suggestion for Indiegogo, Kickstarter and other crowdfunding venues that still want to attract new and upcoming entrepreneurs: Cover the accounting and auditing costs by either hiring or contracting out those services to a third party, and then fold the costs into the price of using the funding portal.
If done on a large scale, it could be made affordable (think: LegalZoom.com), and give these crowdfunding venues an edge over their Wall Street competitors.
Rep. McHenry is to be praised for his efforts, even if they were watered down in the Senate, to help raise unrestricted capital on the Internet. This may yet help free up some $6 trillion in savings to be used readily in investments, and potentially create millions of jobs.
But now the hard work begins for crowdfunding venues to cut through the red tape, and make it accessible to new businesses that have no capital, just the next big idea.
Robert Romano is the Senior Editor of Americans for Limited Government.
