On November 3, 2011, with a bi-partisan 407-17 vote the U.S. House of Representatives passed the Entrepreneur Access to Capital Act (H.R. 2930 and the “Access to Capital for Job Creators Act” H.R. 2940) (the “Acts”). The bills will now go to the U.S. Senate for reconciliation.
This Acts amend the Securities Act of 1933 to essentially allow “general solicitation,” heretofore illegal, in small offerings of investments if they meet numerous other restrictions. The Acts allows an issuing company to offer and sell securities, without regard to the general solicitation–type methods of promotion used, to an unlimited number of purchasers, so long as no purchaser is allowed to spend more than the lesser of $10,000.00 or 10% of his or her net worth, and the total amount of securities purchased within any 12 month period is no greater than one million dollars. And purchasers need not be “accredited” (usually meaning having a net worth of no less than one million dollars or annual income of $200,000.00 or $300,000.00 if purchasing jointly with a spouse). (And, if the issuer provides potential investors with audited financial statements, the offering may be as much as two million dollars. This may be particularly important in light of the ease of auditing a newly formed issuer with no history of operations and earnings).
Also, the Acts allow entrepreneur issuers to utilize “intermediaries,” who need not be registered as broker-dealers with the SEC, to assist in finding investors. This is a significant change from the present law, albeit with many restrictions on the use of the intermediary.
This is a “sea change” in the law of private placements. Perhaps its greatest significance is the new ability of such issuers to use the internet in private offerings. Also, it allows many potential investors, not sufficiently affluent to be “accredited,” to participate in an admittedly limited method in the growth of entrepreneurial companies. And, of course, it opens to entrepreneurial companies’ access to a body of investors hereto for prohibited to them.
However, some of the “restrictions” on crowdfunding should cause some companies to select other methods of private placement, particularly those who can attract sufficient accredited investors. These negative factors should also cause the Senate, in its considerations, to consider improving this new exemption.
Under pressure from state regulators, who believe that the $10,000.00/10% of net worth restrictions are too high and still allow purchases by unsuitable (i.e. non-affluent) prospective investors, it is likely that the Senate versions and eventually the House versions, if adopted at all, will decrease the minimum investment allowed by each investor. Even without such reduction, the amount that most persons will invest will be significantly smaller than that of average private placements under present law. This will result in there being many more investors–many more holders of interests in the entrepreneur’s business–than in traditional private offerings, increasing the cost of administering investor relations. And precise administration of investor relations is crucial to an entrepreneurial business’s ability to get future financing from venture capitalists or to achieve an exit event such as a purchase by a larger company.
Perhaps worse, the presence of many persons with the right to vote on whether to go forward with future financings or exit/liquidity events, perhaps requiring giving significant pre-emptive voting or other rights to venture capitalists, may also hinder such future financings. For this reason, crowdfunding, if it ever becomes law, may better be used for debt or other investments which do not include voting rights.
Also, the House bills require that the issuing company engage a “qualified third-party custodian, such as a broker or dealer registered” with the SEC or an “insured depository institution” to handle its “cash-management functions.” The bills do not define “cash–management” functions, and the issuer may have difficulty retaining a custodian, at least until prospective “cash managers” receive some assurances that they do not face the same problems which cause registered broker-dealers to avoid involvement with entrepreneurial issuers.
Crowdfunding, should it become law, will significantly improve the fundraising opportunities for some companies. However, it will not be best for all companies and will prove complicated and problematic even for those companies it benefits.
Posted by Attorney Joseph R. Soraghan. Soraghan practices in legal matters pertaining to business operations and growth. He guides businesses in financing, contracts, acquisitions, mergers, and sales. Soraghan frequently resolves commercial disputes as an arbitrator or mediator, or through litigation. He is past president of the Missouri Venture Forum.
Reprinted with permission by the Missouri Venture Forum, Enterprise, December 2011 issue.