North Bay Business Journal

Monday, December 9, 2013, 6:55 am

Regulators get closer to rules for ‘crowdfunding’


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    NORTH BAY — As regulators prepare to finalize rules connected to the crowdfunding components of the 2012 Jumpstart Our Business Startups  Act — or JOBS Act — financial experts in the North Bay and beyond are contemplating the impact that the emerging investment mechanism will have for small business and the companies that serve them.

    Is crowdfunding a viable alternative for business finance?

    • Yes (34%, 18 votes)
    • No (42%, 22 votes)
    • Don't know (24%, 13 votes)

    Total voters: 53
    Polling period: December 11, 2013 @ 12:00 pm – December 18, 2013 @ 12:00 pm

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    With a 90-day comment period already under way, the SEC has asked for what could be the final round of critiques before its proposed rules as of Oct. 23 go into effect. If the crowdfunding provisions under Title III of the JOBS Act are approved, the rules will authorize what are expected to be hundreds of Financial Industry Regulatory Authority-approved “portals” that will allow owners of small businesses to embark on small-scale public offerings online.

    It is not the only closely watched provision of the JOBS Act involving the SEC, but is one that has generated broad interest. Others include Title I, which allows some companies to proceed confidentially in a public offering, and Title II, which allows companies to directly advertise private placements on the Web and elsewhere but requires investors to be the higher net worth investors accredited by the SEC.

    The modern practice of crowdfunding is not entirely new, already used as a capital raising mechanism on Web-based platforms like Kickstarter and Indiegogo. Yet an important distinction exists: while those platforms operate by allowing companies to reward individuals for what are technically financial donations, the Title III-authorized sites will involve the sale of company stock.

    Advocates of the approach say it stands to have a democratizing effect in the investment world, providing more moderate-income individuals a vehicle to invest directly in small business and access a world of investment generally left to wealthier accredited investors authorized by the SEC. Yet time will tell how factors like costs associated with the approach ultimately factor in to the cost-benefit analysis of businesses considering other routes like a traditional loan from a financial institution.

    “This is essentially the democratization of investment opportunity,” said Robert Hunter, founder of Marin Wealth Advisors in Larkspur and a self-described “small business evangelist” discussing crowdfunding with business groups in the North Bay. “It’s essentially building social networks to get people to invest locally. These people will be tremendous advocates for the businesses they invest in.”

    As currently proposed, the rules allow companies to raise up to $1 million from the general public over a 12-month period. The rules include varying tiers of financial disclosure required based on the level of capital raised: two years of financial statements certified by the main owner and a most recent tax return for $100,000 or less, audited financial statements between $100,000 and $500,000 and a full financial audit between $500,000 and $1 million, according to the SEC.

    Those disclosures have been a key concern in the rulemaking process, with a balance sought to help prevent fraud while keeping requirements practical for small business. Total expenses will vary based on required disclosures and the commission rate paid to the intermediary facilitating the transaction, but are estimated at up to $18,560 for the smallest tier, $66,410 for the middle tier and up to $152,260 for the largest offerings, according to the SEC.

    The mechanism is largely seen as a way for investors to support a popular local company — like a restaurant, bakery or retailer — and the amount that an individual can invest is limited. Yet it is not the only option for a business to raise local capital, sharing some notable similarities with a direct public offering or “DPO,” said Marco Vangelisti, a former investment banker, lecturer and advocate in the so-called Slow Money movement in California.

    The approach allows a company to sell shares directly to individuals, unlike the intermediary required in Title III or a full-blown initial public offering. And while larger offerings require SEC registration, an offering up to $1 million sold only within the state where the company is headquartered can typically avoid that burden and file solely under the generally less onerous requirements of state regulators.

    The number of shareholders is a key concern in a DPO — too many, and it would trigger further disclosures with the SEC and a higher regulatory burden for the company. The approach tends to draw larger investments from individual shareholders, while the proposed crowdfunding mechanism is expected to attract a larger number of smaller investments.

    “If you are very rich, you have more access to investment opportunities,” Mr. Vangelisti said. “This means that the rest of the people who are not very rich — the 95 percent of us — do not have access to those investment opportunities.”

    “The JOBS Act opened a pathway for that investing to occur,” he said.

    Community bank trade groups like the Independent Community Bankers of America have been taking a largely wait-and-see approach as the SEC finalizes its Title III rules, focusing instead on other provisions of the JOBS Act like those that have lowered reporting requirements for many bank holding companies.

    Yet crowdfunding could also help support banking activity by helping businesses to boost their economic footing and providing a new capital mechanism for a changed economy, said Kimberly Kaselionis, a long-time advocate of capital programs for underserved borrowers who served as CEO of Novato-based Circle Bank before its sale to Portland-based Umpqua Bank.

    “I think there is a significant opportunity for banks to work with the community,” she said. “From the average American’s perspective, they’re going to have the ability to participate in wealth creation through ownership of private companies in their communities. They can invest in companies they know and trust — it helps to democratize and decentralize investment in this country.”

    That local investment comes with ancillary benefits as well, said Fred Groth, who runs Sonoma craft distillery HelloCello and Prohibition Spirits with his wife, Amy.

    Mr. Groth spoke by phone while entertaining a limoncello-making class from San Diego, all attending as a reward for contributing to the $22,689 the company raised on Kickstarter in January.

    “That’s part of what you get out of it — it’s new fans,” he said. 

    Comments on the proposed rules will be open until February 2014.

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