Impacts of New SEC Crowdfunding Regulations (Archived Report)

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Impacts of New SEC
Crowdfunding Regulations

by Nancy

Docid: 00021381

Publication Date: 1602

Report Type: TUTORIAL


The SEC’s final rules implementing
equity-based crowdfunding impose big up front costs, tight fundraising
caps and onerous reporting requirements on startups seeking seed capital
from ordinary investors. And while the US is throttling down the prospects
for equity crowdfunding for early stage capital formation, other developed
world players are aggressively executing strategies to expand such opportunities for innovators and
small- to medium-sized businesses.

Report Contents:


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US Equity Crowdfunding Implementation: The 2012 JOBS Act legislated
creation of a new mechanism for early stage capital formation:
Equity crowdfunding. In a nutshell, equity crowdfunding is like
social media charitable crowdfunding (GoFundMe, Kickstarter,
and the like) but, in addition to moral rewards, funders also get
equity – stock – and the potential for financial returns. In theory,
this promised many good things. For average investors, it offered
potential financial returns. For small- and medium-sized businesses
(SMBs), it offered opportunity to
raise modest amounts of seed capital from online and local
communities of interest. And for the overall economy, it offered two
beneficial side effects: First, small investor based
crowdfundraising has a track record for helping businesses accrete
engaged, brand loyal customers. This
“virtuous circle” tends both to sustain early stage
businesses as they mature and
improve the returns of startup investors. And
second, it protects the broader economy by providing
innovators and entrepreneurs alternative access to capital in the
event of another financial crisis. It is a great idea, a
simple idea, and an idea that has proven very successful in other
parts of the world.

But, as is almost always the case, the devil is in the details. While the nine page legislation mandating equity
crowdfunding passed the US Congress with extraordinary bipartisan
support, the rulemaking process necessary to implement the law
quickly and predictably became mired in financial industry special
interest machinations. In its final form, the SEC’s nearly 600 page
Equity Crowdfunding rules publication imposes onerous filing and
reporting requirements on businesses seeking seed capital by these
means. As a practical
consequence, in 2016 US startup fundraising will
still mostly employ “Part D” equity offerings, which
exclusively target accredited investors.

In spite of this, expect to
see the first implementations of Equity Crowdfunding portals and
online brokerages up and running in mid-2016. Given the US
regulatory environment, however,
we can also expect to see an exodus of startups seeking crowdsourced
seed funding of $500,000 or more as these companies head for locales like Italy,
Australia, Israel, and the ASEAN countries, all of which are openly
courting innovators in search of crowdfund seed capital.

Global Perspective: Politics and policy may have
irretrievably crippled Equity Crowdfunding in the US, but
worldwide it is a proven mechanism, both in terms of its
effectiveness in growing early stage businesses and in jump
starting innovative new lines of business for established
enterprises. The World Bank and several national governments have
successfully implemented crowdfund investing portals in a broad
spectrum of economies. Documented results so far include:

  • Growth
    of private capital markets
  • Decentralized
    and democratized capital formation
  • Rapid,
    market-driven innovation
  • Higher
    than normal success rates and longevity for crowdfunded SMBs
  • Encouraging
    levels of economic growth in locales that accredited investors


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Crowdfunding Debt and Equity Markets: Something New Under the

Small scale, community-oriented investing is not new. Grameen Bank
pioneered something like it in Bangladesh in 1976, winning the
bank and its founder, Mohammed Yunus, a Nobel Prize. Grameen
organized small, socially-based consortiums of impoverished women
and made micro loans for items like sewing machines and
typewriters. Only one member of a consortium could have a loan
outstanding at any time, and loans were jointly secured by group
members. Small businesses flourished. Social pressures virtually
assured loan repayments, and newly empowered entrepreneurs helped
build local economies.

Fast forward to 2012, with the US deeply mired in an
intractable recession:
a spirit of hearty
the US Congress passed the JOBS Act. Both
parties enthusiastically supported the creation of
a regulatory framework for equity crowdfunding,
which at the time was broadly viewed as a low
cost, low risk, populist solution that would
allow innovators and entrepreneurs to sidestep
the frozen banking systems that were inexorably
extinguishing US SMBs.

however, clearly looked like a zero sum game for
financial industries, a nightmare which could
only have taken place at that particular moment
in history: Owing to abysmal public perception
of the industry as a whole and the spectacle of
some of the largest financial institutions in
the world approaching the taxpayers hat in hand,
begging to be bailed out, the
banking industry simply had no opportunity to
kill crowdfunding legislation at that time.

FINRA Moves the Goal Line:
For any social policy, implementing
regulations define where benefits flow, who
exercises control, and how integrity,
security, and transparency are assured.
Because the federal regulatory process moves
slowly and, in a practical sense, regulations
matter more than laws, time was on the side of
traditional investment banking interests in
the case of equity crowdfunding. With the
Great Recession in the cultural and social
rear view mirror, accounting, investment
banking, and financial services interests have
succeeded through massive lobbying
efforts to eliminate most of the
democratization that equity crowdfunding would
have brought to the early stage capital
formation process for
startups and innovators. Notably, the
regulations do these things:

  • Tighten the fiscal
    criteria used to determine who is able to
    invest and cap ordinary investor
    participation at very low levels.

  • Impose
    substantial upfront fundraising
    costs for equity issuers
    seeking to raise over $500,000

  • Mandate costly annual auditing and reporting requirements
    on crowdfunded enterprises.

  • Limit fundraising to
    $1 million USD in a twelve month period.

Equity Crowdfunding markets will go
live some time around mid-2016. The
effective gatekeeper and designated
administrator for Equity
Crowdfunding offerings is
the Financial Industry Regulatory
Authority (FINRA). FINRA
is a
private, member-owned
organization of the US financial

online portals and brokers/dealers
who want to participate
in Equity Crowdfunding
transactions must register with
FINRA. FINRA is empowered to make
regulations concerning how many portals and
dealers there are, the exact
nature of processes for
screening and approving portals
and dealers, the timeline and
costs associated with the
approval process, and how
various parties will be treated
under the new regulations.

SEC comments published in the Federal
Register along with the implementation rules
estimate that when all of the investment
services and compliance costs are taken into
account, raising seed capital of $500K to $1
million would cost from $44,000 to $94,000 up
and ongoing reporting would cost
between $3,000 to $13,000. Lower
levels of fundraising are dramatically less
costly, but would probably be attractive only
to businesses that aren’t trying to
grow that much. This has an inherently
dampening effect on investor interest.

The combined chilling
effects of high upfront costs, expensive ongoing reporting and
compliance costs, low annual caps on fundraising, and near
total uncertainty about how FINRA will wield its authority
effectively mean that most fast growing startups in the US
will need to go the "old school" route, using investment banks
and the “Reg D” IPO process. This capital formation
process exclusively solicits funding from high net worth
“accredited investors” – venture capitalists.


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observers who had high hopes for US leadership in capital
formation innovation, the Equity Crowdfunding story
isn’t a happy tale to this point. It appears that Big
Finance may have used its
lobbying advantage to write rules for Equity
Crowdfunding that largely subvert the original intents: To
democratize early stage capital formation and to prevent a
future crisis in the financial industry from extinguishing
small enterprises by locking SMBs out of access to

While the
financial industry may have been the only game in town when it came to exerting
influence over drafting the regulatory framework for equity crowdfunding, that
tactic fails to take into account one fact that is both obvious and pivotal:
Being the only game in town only matters if Washington, DC, is the only town.
And it isn’t. 

If the last ‘American Century’ demonstrated anything, it is that
there are a whole lot of ways to start and sustain a
business. Having access to cash is certainly one of
them, but it is by no means the only one or even the best
one. Rather, all you
need to start and stay in business are assets that make
you productive, workers that take pride in their product
and consistently deliver quality, and committed, brand
loyal customers. In the emergent sharing economy,
entrepreneurs can get a lot of those things without much cash investment.

The Sharing
Economy’s Fundamental
Theorem: Lifestyle
Growth Rates >
Income Growth

Even in
its dramatically watered down 2016 implementation,
Equity Crowdfunding and the sharing economy form an
important confluence. Together they are poised to present if not a perfect storm then, at the
very least, some serious headwinds for institutionalized


Recession, Millenials’ parents saw job loss, wage
cuts, and foreclosures mercilessly strip their wealth
away. At the same time, ballooning college costs made it impossible for middle
class families to pay upfront to educate their
kids. Seeing the opportunity largely created by
the recession, banks rapidly and aggressively
moved into for-profit student loans. Predatory lending
practices by banks (most student loans are federally
insured, protecting lenders from default at the
expense of exposing borrowers to huge repayment risks)
plagued an entire generation with
crushing student debt burdens. 

result: Consumerism, pretty obviously, has hit a
cultural and volitional cul de sac. Millennials
still want to live well, but that is not nearly so
tightly coupled to owning things as it was a
generation ago. Particularly things that involve
debt. Hence, we see the rise of the sharing economy.
Why own a house, a car, or even a game console? Why not
just share the things you won’t use a lot? Or why not only pay for the amount you actually do
use? It is the engaging paradox of the era:
Sharing means everybody gets more.

Therein lies the
potential for cultural change in attitudes about
entrepreneurial capital formation. If your
startup needs marketing help, and someone who could
provide it wants to share or trade, why bother with
cash, or worse, loans? Why not
ask your customers to crowdfund the upgrade
to your pizza oven, brew pub, or tech business? And
what if
global social media marketplaces spring up
where there are entrepreneurial opportunities for
sharing and collaboration? A savvy innovator quickly
appreciates that institutional financiers no longer
hold the keys that unlock the front door of the
prosperity castle … peers
do, collaborative workers do, and customers do.

are, of course, imagining a very different world
view and, for it to be widely held,
there would have to be extreme cultural anathema
towards the US financial industry. Is this an emergent trend, possibly a big
phenomenon, "big" like on the scale of plate
tectonics and continental drift? The answer: A guy
who seems to own one suit and describes himself as
a “Socialist” almost won a US Presidential primary


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The World Surges

Worldwide, crowdfunding frameworks are evolving rapidly. The
ASEAN nations, Italy, and Australia have
aggressively pursued the extension of existing
crowdfunding frameworks in hopes of jumpstarting
capital formation for entrepreneurs. In Italy’s
case, this was a key component in a strategy of
getting in position early to play a dominant
regional role in an emergent niche of the
financial ecosystem. All are significant of a
building wave of interest from national
governments looking to embrace expansion of
crowdfunding as a means of decreasing dependence
on multinational banking interests.

highlights include:

  • Italy’s
    January 2015 modification to its existing
    crowdfunding governance dramatically expands
    participation of both investors and
    fundraisers. For enterprises seeking
    funding, Italy’s new rules embrace startups;
    established enterprises engaged in
    innovation or new product launch; and some
    types of venture capital activities.
    Crowdfunded VC must go to companies which
    have a place of business in Italy, the
    owners of the business receiving funding
    must be EU residents, and the business must
    be engaged in innovation and product
    creation which meet specific requirements
    defined by the Italian Company Registry.
  • Perhaps
    the best crowdfunding implementation to
    go to school on is the Australian Small
    Scale Offerings Board. This institution
    is, relatively speaking, an oldster in
    the online crowdfunding world. In its
    eight years of operation, it has
    achieved a stunning 80 percent survival
    rate among businesses that received
    crowdfund financing. In addition, there
    have been no reported incidents of
    countries are aggressively pursuing
    use of crowdfunding as a means of
    strengthening and expanding the SMB
    economic base in the region. Support
    and initiative is coming from the
    highest levels of government. In
    February 2015, the Thai Securities and
    Exchange Commission will host the
    Crowdfunding Asia Summit, in follow-up
    to a very successful inaugural event
    held in Singapore last August. The
    Crowdfunding Asia Summits are pulling
    in power players: High ranking
    politicians and policy makers;
    entrepreneurs; investors; and leading
    lights of the global crowdfunding
    movement are going all in on
    establishing the necessary
    infrastructure and regulatory


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It Right: The Interesting
Successes of Australia’s
Small Scale Offerings Board

is always worth carefully studying
something that works, and inarguably,
Small Scale
Board has
a crowdfunding system that is at the
top of the developed world’s honor
roll of crowdfunding implementations.
Better than 80 percent of the enterprises
funded over its lifetime are still in
business. This is nothing short of
astonishing, given that the US Bureau
of Labor Statistics reports that less
than 50 percent of US small
businesses make it past four years.
There are a few solid theories about
what accounts for this:

  • Before
    being accepted to the ASSOB
    crowdfunding platform, applicants’
    business plan, proposal and
    financials are reviewed by
    professional accountants employed
    by ASSOB. This screening function
    eliminates most unqualified or ill
    prepared fundraisers.
  • Crowdfunding
    resources that go to
    microenterprise are typically
    plowed right back into the
    enterprise—often to hire key
    people or fund enabling
    infrastructure. Global data seems
    to indicate that SMBs which find
    relief from capital constraint
    rapidly expand revenues and add
    employees. In essence, it is a
    validation of the old adage that
    “It takes money to make money”.
  • Successful
    crowdfunding seems to create
    confidence in the mind of the
    entrepreneur and expectations on
    the part of the investors,
    resulting in a self-reinforcing
    cycle of performance improvements
    and increasing investor
    expectations. In other words, the
    social interaction between brand
    and investor doesn’t end with the
    investment. Rather, there is
    ongoing engagement, with investors
    often becoming brand loyal
    customers and entrepreneurs
    calling themselves to ever higher

Grass Roots Equity Funding to Become A Disruptive Force in
Consumer Focused Market Spaces

there is a substantial body of evidence that crowdfunded SMBs can
steal market share from nation- and worldwide franchises, because
equity crowdfundraising inherently builds a brand loyal, actively
evangelical customer base.


SEC Issues Proposal on
SEC Final Crowdfunding Rules Document:
Whitepaper from Crowdfunding
Pioneers Weiss, Best, and Cassidy-Dorion:

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2016 Crowdfunding Portals

About the

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Nancy Nicolaisen is an author, researcher, and consultant
specializing in designing innovative solutions based on small,
mobile, connected devices.

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