Sunday, February 16, 2014

Top Challenges Facing Crowdfunding In 2014

Crowdfunding is here to stay.  We can thank a nimble small business lobby and some hardworking people in Congress and the SEC for getting the ball rolling.  Okay, maybe more private groups than just the small business lobby work hard, because it sure takes a long time for the policy framework to accommodate reality.  Here's my rundown of where policy needs more work right now.

The SEC must finalize Reg A+.  This proposed regulation allows a hybrid public/private securities offering beneath a specified cap.  I think this helps get around the difficulties small companies will face if they present pitches at public events.  Offering the securities under Reg A+ will alleviate some of the heartburn investors like me feel at pitchfests when a startup shows ignorance of offering circulars and blue sky requirements.

Reduce market barriers to SPOs.  I'm painting with a broad brush here because there isn't just one fix.  OECD Corporate Governance Working Paper No. 10 addresses the decline in IPOs on US exchanges.  Venture-backed startups with large addressable markets have no problem going IPO once they've crossed the chasm to market adoption.  They know there will be a large demand for aftermarket trading.  There is little such aftermarket for those small companies that go IPO under the gradations of the JOBS Act and its supporting regulations like Reg A+.  I do not agree with some analysts who think the decimalization of tick size is deterring IPOs.  I like decimalization because it makes prices less sticky in the market and allows for more accurate price discovery.  My preferred solution is to allow companies that go IPO to continue to issue secondary shares under the JOBS Act.  I see resource companies presenting PIPEs all the time.  Tech companies should be able to do that with an SPO that works the same way as a direct public offering (DPO).  Crowdfunding portals associated with FINRA broker-dealers can easily handle DPO and SPO volume, and can develop aftermarkets that encourage more IPOs.  Portals like SecondMarket are already out in front.

Stick with the changes to Reg D.  The investor community has had enough time to adjust to the SEC's repeal of the ban on advertising and general solicitation of Reg D offerings.  Some critics still haven't made the adjustment.  Tough luck.  There shouldn't be any going back now and the SEC should stick to its guns.

Bring policy innovation to Canada.  Our friends in the Great White North should share in the new era of blessings that crowdfunding brings to investing.  Canada already has a robust reporting regime that allows for nuanced classifications of mineral and energy deposits.  This allows young companies to report results that can help them raise capital.  It's time the capital raising regime caught up to the mineral classification regime.  Canada's Venture Capital Markets Association (VCMA) is trying to move that country in the right direction.

Simplify restricted stock rules.  Rule 144 still contains minefields for investors holding restricted stock.  I believe the SEC should simply the processes available for owners to remove the "restricted" legend from a stock.  If I could wave a magic wand, I would eliminate the one year minimum that shell companies must wait after filing Form 10.  I also see no reason why the SEC requires an attorney's opinion prior to lifting a Rule 144 restrictive legend.  I do not expect the SEC to move on these matters until it is done wrangling with more pressing JOBS Act rules.

Publicize "reasonable steps" and "bad actor" provisions.  The startup community is still woefully unprepared to take the SEC's "reasonable steps" to verify an investor's accredited status.  They may also not know that getting involved with "bad actors" can destroy their ability to raise capital if the SEC discovers such a relationship and imposes a sanction.  The SEC could make it easier by publishing description of those two concepts in big, bold letters on its JOBS Act pages.  I don't expect that to happen, so these subjects will remain lucrative practice areas for law firms that pitch services to startups.

Clarification on Edgar filings.  The SEC requires publicly traded companies to file their financial statements on Edgar.  Startups who migrate entirely to capital raising via crowdfunding portals will IMHO become de facto publicly traded companies.  I do not know whether this means they will have to file on Edgar.  The SEC should get ahead of this now and issue some regulatory guidance.  It shouldn't have to wait until investors start suing small companies for not publishing on Edgar if they are supposed to be exempt.

The SEC has a small business guide and IMHO it should clarify the topics I discussed above.  Crowdfunding is the latest policy innovation that follows naturally from the success of the Small Corporate Offering Registration (SCOR) regime.  The NASAA guidelines on SCOR are far simpler than anything the SEC has put in place for the JOBS Act.  It would be nice if everything in finance were so simple.