New World of Crowdfunding Waits as SEC Struggles to Complete its Job

Almost exactly one year ago, a new age for entrepreneurs and investors was supposed to have begun.

On April 5, 2012, President Barack Obama signed the Jumpstart Our Startup Businesses, or JOBS Act, into law. Among the act’s provisions were changes to regulations governing how entrepreneurs, startups, and small companies could raise money through crowdfunding and who would be allowed to invest in companies.

Potential investors and entrepreneurs greeted the JOBS Act enthusiastically. Companies formed to help connect entrepreneurs with investors, including a number in Boulder, CO. Their goal was to build on the online crowdfunding model pioneered by companies like Kickstarter, Indiegogo, and RocketHub, which help raise money for creative projects and social campaigns. In exchange for contributing, donors are given a product like a CD or are able to support a cause.

Globally, crowdfunding platforms raised $2.7 billion in 2012, an 81 percent increase from 2011, according to research and advisory firm Massolution, which follows the industry. Massolution’s report covered more than 300 platforms and more than one million campaigns.

Equity crowdfunding is projected to be even bigger. In its recent “State of Entrepreneurship” report, the Kaufmann Foundation cited a study estimating the total market for equity crowdfunding could be $4 billion.

The regulatory changes promised great things, at least in the eyes of supporters, but the year since has frustrated many and led to major pivots for some companies that formed to act as connectors between investors and entrepreneurs.

“I’ll admit, I went into this with wide eyes, thinking this would mark a renaissance for investors,” said John Metzger, co-founder and CEO of TeQuity Capital & Communications, formerly the Story Stock Exchange, which was launched in Spring 2012.

Finding Capital and Making Connections

Finding the money needed to get a company off the ground is a problem shared by almost all entrepreneurs. While it may be easier for some—like serial entrepreneurs with a successful track record running software startups—for new entrepreneurs it is one of their biggest challenges.

Raising money from the proverbial “friends, family, and fools,” is an option, but their resources are finite, and the pool of angel investors can vary greatly by area and industry. A first-time entrepreneur likely will have a limited network, and while his or her idea might be sound, it might not offer the high returns venture capital firms want.

Reaching out to the public is not a possibility either, because of SEC rules against general solicitation.

Equity crowdfunding is supposed to help entrepreneurs overcome those hurdles.

While crowdfunding has been around for a few years, before the JOBS Act it was limited to companies, individuals, or organizations making a product, starting a creative project, or raising money for a philanthropic campaign. The key innovation of the JOBS Act was to allow entrepreneurs to sell part of the company in exchange for investment. The law allows companies to raise up to $1 million a year through selling shares.

As with Kickstarter, they would be able to use online platforms that would broaden their reach and connect them with investors far outside their geographic area or personal network.

The platforms would be more democratic as well, because regulations limiting investors to “accredited investors”—read rich people, financial institutions, and VCs—were relaxed for individuals using the platforms to invest.

Entrepreneurs and the media quickly recognized the potential benefits and foresaw a world where entrepreneurs could amass many small investments from around the country to support their companies.

“That was really the Holy Grail, the promise of what it would be, and that’s just not working out,” Metzger said.

While skeptics point out there might be natural limits on how successful equity crowdfunding could be, the immediate reason for the holdup is the SEC.

The JOBS Act required the commission to create the rules governing equity crowdfunding within nine months of its passage. The SEC has missed its deadline, and it is not expected to complete the rules until late 2013 or early 2014.

The delays have dashed the hopes of entrepreneurs who hoped they would be able to launch their companies through equity crowdfunding, TeQuity president and co-founder Michael Abdy said.

“The act did provide false hope for a lot of startup companies in the sense it was supposed to be a solution to the gap a lot of these companies needed to fill,” Abdy said.

Despite the deadline set by Congress, it was foreseeable the SEC would struggle to meet the timeline, said Richard Levin, a lawyer specializing in representing early stage and public companies. Levin has extensive experience in securities law and working with regulators, and he says what’s happened with the JOBS Act is not out of the ordinary.

“This process is taking as long as any other rule making,” Levin said. “There’s nothing unusual about this.”

Levin praised SEC staff as hardworking and thoughtful, and he noted it usually is understaffed. It also is wrapping up work on the Dodd-Frank Act, which required it to create numerous new rules governing the banking industry, he said.

Turnover among the commission’s leadership also has been a factor, Levin said.

Changing Course

The slow progress has forced companies hoping to create startup-crowdfunding platforms to rethink their models or step back from crowdfunding.

One of those companies is Funding Launchpad, which formed in Boulder in January 2012. Funding Launchpad’s founders watched as crowdfunding was debated in Congress and wanted to be one of the first companies with an online platform connecting investors and entrepreneurs, said Shane Fleenor, a co-founder and chief legal officer.

Funding Launchpad lobbied the SEC and established relationships with entrepreneurs looking for investment. Its founders regularly appeared at forums explaining how the new regulations would work.

The startup even worked with a company named Couragent to legally sell shares to residents of Colorado, Illinois, New York, Wisconsin, and Wyoming. That relationship required the companies to work with regulators in each state and to follow each state’s distinct laws.

But because of the delay, Funding Launchpad no longer focuses on helping startups raise investment through selling equity. Now it works with small companies like restaurants, retail shops, and service providers to help them raise $25,000 or more. The campaigns follow the model pioneered by Kickstarter and are donation-based. Companies will reward donors with something tangible at the end of successful campaigns.

Funding Launchpad also is exploring forming relationships with registered broker-dealers, who already buy and sell securities. The JOBS Act allows broker-dealers to act as intermediaries between companies and small investors, essentially doing the same job online platforms were supposed to perform.

Metzger and Abdy also have modified their plans. The Story Stock Exchange intended to develop a small portfolio of promising startups investors could support. Story Stock Exchange also would provide mentorship and services such as public relations and marketing advice in exchange for a stake in the companies. It was an early investor in Funding Launchpad.

Last fall, Story Stock Exchange changed its name to TeQuity and now directly invests in companies, much like traditional angel investors. The deals are for seed rounds and the amounts are between $25,000 and $50,000, Abdy said. TeQuity will continue to provide services to companies it invests in.

The delays also have led entrepreneurs that would have sold equity through crowdfunding to transition back to campaign-based crowdfunding, said Jonathan Beninson, CEO of First Funder, a Boulder-based platform geared to entrepreneurs and organizations combating social problems.

For companies seeking to connect investors and entrepreneurs, the future could be bright if they can wait out the SEC—and if companies like Kickstarter continue to have success. Massolution anticipates global crowdfunding volumes to exceed $5 billion in 2013.

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