As we mentioned in our recent blog post about advocating for the investment crowdfunding regulatory framework, the SEC is inviting the public to comment on the JOBS Act, including the investment crowdfunding provisions found in Title III. Funding Launchpad formally submitted our comments to the SEC on Friday, April 27. Our comments can also be found below.
We encourage everybody with interest in investment crowdfunding to share their views with the SEC. Its very easy to do, and you may influence the final rules that will govern the industry!
Vim Funding, Inc / Funding Launchpad
Commentary to Title III (Crowdfunding) of JOBS Act
Vim Funding, Inc is the creator of the Funding Launchpad, an equity crowdfunding intermediary. Our founders have been watching this space for many months, parsing and poring over the details of each crowdfunding bill introduced in the House and Senate. All in all, we believe the final law is a good faith effort to balance investor protection and economic growth.
We have some thoughts on how the SEC can best implement Title III of the JOBS Act. These ultimately boil down to one overriding principle that we believe is paramount: regulate the intermediaries more, and the users less.
As an intermediary, you’re probably expecting us to come out in favor of light regulation, of a painless funding portal registration process, and generally a system that makes it easier for us to go about our business. But that is not our position. Our position is that, as the ones whose business expressly involves interjecting ourselves into the middle of the financial system, of registering with the SEC and joining an SRO, of dealing with crowdfunding on a daily basis, it is only natural that we should shoulder the regulatory burden for this new crowdfunding regime. We’re the ones who should be digging into the code and the rules, working with our lawyers to develop a platform that is fully compliant; we’re the ones who should be responsible for ensuring that the system is sustainable, and that investors are protected.
It makes far less sense to place these burdens on the small businesses using our services. They’re just trying to get financing for their business; they shouldn’t be expected to have a mastery of securities law, any more than small businesses today are expected to be expert in bank regulation just because they have a line of credit. Moreover, a typical issuer will only use this exemption once or at most a handful of times, and so is not well positioned to bear the bulk of the procedural requirements of the exemption. If the SEC places too great a burden on the issuers using the platforms, it could create a chilling effect and deter would-be entrepreneurs and businesses from using crowdfunding. This would undercut the job-creating, economy-stimulating capability of the JOBS Act.
We believe that the jobs Congress intended to create through the act are not those of broker-dealers and funding portals, but rather of the start-ups and small businesses that these intermediaries will serve. This is the basic premise of our “regulate the intermediaries more and the users less” philosophy. Intermediaries are just that: an intermediary. They are an essential feature of crowdfunding, but they are not what crowdfunding is about. If the burden on crowdfunding intermediaries is high, it may deter a few of the lazier would-be platforms from coming to market – but the rest of us will allocate a little more of our budgets towards compliance costs and move forward. On the other hand, if the burden on issuers (or on potential investors) is too high, it is likely that the machinery of crowdfunding will be under-utilized – which in turn means our small businesses will remain unable to obtain the cash they need to grow, to create jobs, and to stimulate our economy.
Please allow us to clarify what we DO NOT mean by this principle. Naturally, the issuer should be subject to robust disclosure requirements. Investors need to be given adequate, standardized information about the investment opportunity so they can make an informed decision. The issuer should set target raises and specify share prices; they should describe well their anticipated use of proceeds. Likewise on the investor side, we think the per-investor limits in the act are sensible, and we agree that investors should positively affirm that they understand the inherent risks.
We take these fundamental safeguards as a given. However, we believe the SEC can uphold these requirements while taking steps at the margin to lessen the burden on issuers. We’ve spoken to numerous entrepreneurs and small businesses regarding crowdfunding, and their biggest concern is the high up-front costs they must incur just to go to market, which they must pay without knowing whether their raise will be successful. Most issuers cannot properly prepare a disclosure document; they’ll have to engage securities attorneys. Whether their legal bills for preparing disclosure materials are four figures vs. five figures will depend in large part on the disclosure forms mandated by the SEC. Although we believe that adequate disclosure is necessary, we fear that “overkill” disclosure requirements will render crowdfunding too expensive for many issuers, and we implore the SEC to seek a balanced approach here. For instance, we believe something akin to NASAA’s 1989 Form U-7 would be an appropriate standardized crowdfunding disclosure document — whereas the 1999 re-draft U-7 seems like overkill (as evidenced by the fact that the SCOR regime is rarely used, due in no small part to the costs and burdens of preparing the form).
Similarly, we question the wisdom of the audit requirements – if there are two companies with limited operating histories, does it really make sense to require one of them to spend thousands more than the other getting its financials fully audited, simply because its business plan requires a larger target raise amount? Now, after a successful raise, we can see why the SEC may be stricter on an ongoing basis with an issuer with $1 million in “crowd” equity than with an issuer who raised $50,000 – and that’s fine, because after a successful raise, the issuer will be better able to afford accounting fees. But, consider a situation where a start-up with no cash in the bank believes it needs $700,000 for launch, but it sets its target raise at $500,000 to save on audit fees that it cannot afford to pay. Without the audit requirement, the investors in the $700,000 raise would have seen the same reviewed financials as the investors in a $500,000 raise; the information they received would have been no worse. But, the investors in the $700,000 raise arguably have a much better chance of seeing their investment succeed, because the issuer was free to raise the funds it truly needed, without worrying about additional up-front costs that it could not afford to pay. Of course, the SEC must work with the law it has been given, but we note that the act gives you the discretion to raise the threshold at which audits are required, in theory all the way up to the $1,000,000 level. We ask that you consider exercising this discretion.
Along the same lines, we believe that the law should be clarified to permit a “minimum/maximum” raise, rather than insisting upon am “all or nothing” raise, provided that an issuer adequately explains how it could effectively deploy a range of amounts. For instance, a craft brewery might explain that if it raises $x, it will build its brewing and bottling facility; if it raises $y, it will add a small tasting room so the public can sample the beers and purchase bottles for off-site consumption; if it raises $z, it will open a bar adjacent to the brewery where customers can purchase and consume the company’s beers on the premises. Such flexibility will encourage issuers to focus on funding milestones, and will allow them to seek the amount of funding they believe they need. An all or nothing requirement, on the other hand, will tend to incentivize issuers to seek smaller raises – even when they believe they would benefit from a greater amount – because they would rather succeed at raising a smaller amount than fail at raising a larger amount. Again, this would be riskier for investors than it would be if the issuer set the raise amount at the level it believes it truly needs.
Another possibility that we invite you to consider is a “testing the waters” provision for crowdfunding, similar to the mechanics in Regulation A. If issuers could, at a low cost, obtain some confidence that their raise will be successful, they may be more inclined to spend their literal bottom dollar on the legal and accounting fees necessary to undertake a crowdfunding offering. Similarly, it should be clarified that intermediaries can charge contingent, transaction-based success fees. Not only does this align the interests of the intermediaries and their clients, but it also reduces an issuer’s up-front costs, since the issuer will only pay after it has successfully raised funds.
Along similar lines, we believe the user experience for investors should likewise be a relatively painless process. As an intermediary, we will verify/vet potential investors in such manner as the Commission sees fit. Likewise, as noted above, we’re in favor of mandatory investor education prior to investing. But once appropriately verified and educated, and after having been given full opportunity to review all relevant disclosures, documents, etc, we would like to see investors be able to invest with minimal hassle — whether through an ACH arrangement, or via Paypal (through a linked bank account, not with credit cards), or such other arrangements as may evolve as an industry best practice. One idea is that a first-time investor may have to input his/her full banking information, but investors should be able to authorize the platform to save this information (comparable to the way that consumers are free today to link a bank account to their online brokerage account), streamlining the process for repeat investors. If Paypal can be utilized, then perhaps the investor never has to provide banking information to the intermediary at all. The platforms and their service providers will perform appropriate checks on the back end before funds are cleared, but the investors’ user experience will be simple and hassle free. Just as we argue above concerning issuers, portals can and should be held to high administrative standards as a cost of entering this business — but if too much regulatory burden is placed on investors, the crowdfunding system will fail to gain sufficient traction among users to bring about the desired economic benefits.
These suggestions are intended to exemplify a philosophy that we hope the SEC will consider as a guiding principle throughout the rule-making process. If the SEC heavily burdens the intermediaries, it may force some participants out of the market, but there will be players willing to incur the extra burdens – we believe the supply of intermediary services will be adequate in any event. However, if the SEC over-burdens issuers and/or investors, there is a very real possibility that demand for crowdfunding will be choked off, and our small businesses will not obtain the capital they need to grow. The capital markets are failing our small businesses, to the detriment of our under-employed citizenry. Congress recognized this failure, and passed the JOBS Act in an attempt to rectify the situation. We understand that the SEC is charged above all with safeguarding investors, and we applaud you for your efforts in doing so. We ask only that you focus these efforts on the crowdfunding intermediaries who are best situated to shoulder these costs and decipher these rules and regulations, while whenever possible sparing the issuers who lack the sophistication and the cash runway to shoulder a heavy compliance burden, and the investors upon whose access to the system the crowdfunding regime depends.