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Crowdfunding rules for smaller investors foil firms

August 20, 2016

New federal rules designed to make it easier for small investors to use crowdfunding have hardly gotten traction in Indiana, and crowdfunding platform operators locally are mostly using old rules to help companies raise money.

Last fall, the Securities and Exchange Commission adopted Title III equity crowdfunding rules, which allowed companies to raise capital online from non-traditional investors—to the tune of as little as a few hundred dollars each.

Blackett Blackett

Those rules—widely known as “Regulation Crowdfunding”—took effect this May, but two of the few Indiana firms that run crowdfunding websites said the new rules come with so much regulation that it hasn’t been worth their while to put them to use.

“We took a look at them and there’s still, from our perspective, a lot of dust to settle,” said Jacob Blackett, CEO of Indianapolis-based real estate crowdfunding platform Holdfolio LLC.

“From a legal cost standpoint, I think it’s prohibitive, especially right now.”

Brandon Smith, CEO of Indianapolis-based Localstake LLC, said his firm has been helping companies raise money under so-called securities law “exemptions” that predate Regulation Crowdfunding, because the older mechanisms are less stringent.

smith-brandon-mug.jpg Smith

“There are other exemptions that have historically been available that have fewer requirements in terms of federal filings,” said Smith, whose firm has been helping manufacturing, technology and food-and-beverage companies raise five- and six-figure sums since 2013. “So it’s just easier to put together a deal for a business using those laws.”

There don’t appear to be many crowdfunding intermediaries in Indiana. The Indiana Secretary of State keeps a list of companies registering to use Indiana crowdfunding exemptions, but it has only one name on it—Potluck Capital.

Chris Baggott, Potluck’s founder, said he shut down the platform earlier this month to focus on other business ventures, including food-tech startup ClusterTruck.

crowdfunding-data.gifRegulation Crowdfunding rules are catching on in other states, but not at a breakneck pace. From May 16, when the rules took effect, to Aug. 16, 82 Title III offerings were filed with the SEC nationwide, according to Florida-based Crowdfund Capital Advisors LLC.

So far, investors have committed $6.7 million in capital for those offerings, with the biggest chunk—$2.5 million—going to California-based firms. There’s been no activity in Indiana, data show.

Industry executives and observers said they’re seeing slow adoption across the country because Title III rules come with a bevy of requirements that include hefty disclosure documents and, in some cases, audited financial statements.

The costs of such tasks, which aren’t required under other exemptions, can run in the mid-five-figure range, attorneys said, eating a nice chunk of a capital raise that’s in the six-figure range.

The most a company can raise under Title III is $1 million.

Swart Swart

“There are ongoing compliance costs in which companies have to file reports with the SEC every year,” said Richard Swart, chief strategy officer with NextGen Crowdfunding, an education and research firm.

“And some companies are concerned about using a form of fundraising that requires them on annual basis to hire an attorney or accountant to make sure their reporting is correct.”

Regulation Crowdfunding rules were prompted by the 2012 JOBS Act, which mandated the SEC create rules that made it easier for small businesses to raise capital. The act’s Title II rules allowed companies to solicit offerings online, but restricted those offerings to accredited investors—people with at least $1 million in liquid net worth.

The legislation’s Title IV rules allowed non-accredited investors, but they were intended for late-stage-growth companies looking to raise up to $50 million—not mom-and-pop operations.

The Title III rules were the latest to take effect. They were intended to help small companies, such as craft breweries, raise money from smallish investors efficiently via the internet.

Industry players said they suspect the additional requirements were meant to provide ample protection for amateur investors. But those protections have discouraged corporate use.

Hooper Hooper

“The attractiveness of crowdfunding was that it was going to be a streamlined, efficient way to raise capital,” Barnes and Thornburg attorney David Hooper said, especially for smaller companies with limited resources.

“But what we got from the SEC ... was really more restrictive barriers and not less.”

Jason Best, a principal at Florida-based Crowdfund Capital Advisors, said he sees the crowdfunding market as evolving in a methodical, rational way—which is what’s to be expected for a new type of investment and investor.

He said he anticipates measured growth over the next 18 to 24 months, as familiarity among attorneys and accountants grows. He also said relatively low-cost online tools that aid with tasks like background checks, due diligence and disclosure will continue to emerge.

“Crowdfunding is NOT an EASY way to raise money. It is a NEW way to do a difficult thing—raise money for a business,” Best said in emailed remarks. “What is new is the ability to use the web and social media to raise money more efficiently and in a shorter time period than has ever been possible before.”

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Smith, of Localstake, said he’s been in talks with a company interested in using the new rules, but no action has come yet.

Beyond that, he expects to sit tight until some of the restrictions for Regulation Crowdfunding are eased.

Swart said a bill in Congress, dubbed the Fix Crowdfunding Act, would raise the ceiling from $1 million to $5 million, and make it easier to manage relations with a large number of investors. The bill passed the House in July, but has stalled in the Senate.

Swart said he doesn’t expect it to regain life until after the elections.

“Personal prediction: They will introduce the bill [in] the next Congress,” he said.•

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