While much of the discussion regarding HR 4855, sponsored by Congressman McHenry, lined up along party lines, what was striking was the disconnect between the empirical and the speculative. Several Representatives expressed a “wait-and-see” approach – something that may do their constituents harm.  The Fix Crowdfunding Act should be pushed forward quickly – for the benefit of all.

Why Wait?

A major criticisms of existing Title III rules is one of negative selection. While the intent was to protect those individuals who could least afford to lose money, the cumbersome rules may ironically do the exact opposite. The law of unintended consequences is at play here. Using Reg D, the most popular securities exemption, is a far easier method of raising capital. All you have to do is make certain your investors are accredited (wealthy).  As the thesis goes, some of the companies raising capital under Title III will be businesses that were unable to raise smart money using Reg D.  If the VCs or professional Angel investors aren’t interested perhaps you can convince the “crowd” of retail investors.

One of the most glaring shortcomings of existing Title III rules is the inability to use a Special Purpose Vehicle or SPV.  An SPV can be a legal entity where a group of individuals invests in a company while being represented as a single investor on the cap table. Small companies need to be spending their time building their business and not dealing with the whims of every small investor.  At the same time, a bloated cap table may be a disincentive for future investors to come on board.  The SPV, if allowed to be structured correctly, may allow a professional investor to help guide smaller investors along the way. This approach has been described as the “killer app” of equity crowdfunding by MIT Sloan Professor Christian Catalini. His research has correlated nicely with some of the most successful investment crowdfunding platforms around the world.

Not too long ago I had the opportunity to speak with a founder of one of the most successful equity crowdfunding platforms around. The company spends an incredible amount of time in due diligence. The platform lists securities where you can invest side by side with some of the most famous investors in the world.  This is where smaller investors should want to allocate their risk capital and, in fact, the results have been pretty impressive. Asked about whether or not Title III incorporation is on the horizon the founder stated he would love to but unfortunately cannot, mentioning specifically the lack of an SPV.  Once again, the small guy gets shut out.

AngelList is a global pioneer in internet finance. Since platform launch, AngelList has matched hundreds of millions of dollars from accredited investors into early stage startups. Their syndicate structure (which uses an SPV) has allowed smaller, accredited individuals to join along with professional investors thus combining the pros with the (accredited) ordinary Joes. During the subcommittee hearing last week, Kevin Laws, COO of AngelList, shared his real-world experience explaining to the subcommittee members;

“This bill [HR 4855] … simply brings the protections afforded to accredited investors to the unaccredited investors where they are likely to be even more necessary.” [emphasis added]

And who would be against that?

Retail crowdfunding is not only about providing access to capital for SMEs but investment opportunity to a wider audience. Congress should create an exemption that the very best companies seek out – not just the last company to be selected for the team roster.

It is a fact that most wealth is vacuumed up by professional investors in private companies before trading on a public exchange.  This fact means the current IPO market has become more of an exit instead of an entrance as small IPO’s have all but dried up.  While the cause of this phenomena is multi-factorial, much of this has to do with the economics of going public. These days the most promising companies remain private as long as possible raising capital in successive private funding rounds.  The graph below, courtesy of Andreessen Horowitz, is a visual depiction of the enigma.  You would think our elected officials would want to help alleviate this glaring inequality – one that continues to exacerbate the problematic wealth gap.

The other provisions of the Fix Crowdfunding Act such as enabling “Testing the Waters”, so an issuer can gauge investor interest before launching (and paying for) an offering is an obvious fix.  And increasing the funding amount to $5 million is a common sense change. There are other positive elements in HR 4855 that can turn an OK exemption into a truly promising one. While I have great confidence the Title III market will launch with fanfare and a solid deal flow, it is incumbent upon our policy makers to do what they can to make things better.  Having interacted with many of the platforms intent on leveraging Title III retail crowdfunding, I know they will do what it takes to make it work.

Investing in early stage companies is a risky endeavor. Many small firms will inevitably fail, and investors will lose money. But that is how capitalism works. As it stands now, the deck is stacked against retail investors.  Turning the Fix Crowdfunding Act into law will help address many of the existing shortcomings while improving access to capital and opportunity for all investors – both large and small.

By JD Alois

View the bill at https://fr.scribd.com/doc/307458976/Fix-Crowdfunding-Act-BILLS-114hr4855ih 

Predictions that social impact investing will become the new venture capital got a big boost from a pair of federal regulatory changes this year. One affects foundation investment decisions, and the other affects decisions by pension funds governed by the Employee Retirement Income Security Act (ERISA). Both changes make it easier to target impact investments—those that generate social or environmental impacts alongside financial returns.

Private investor enthusiasm about impact investing has picked up steam in recent years, a trend documented in the 2015 survey conducted by J.P. Morgan and the Global Impact Investing Network (GIIN). All told, survey respondents currently manage $60 billion in impact investments worldwide. They reported committing $10.6 billion in new capital in 2014, up 7 percent from the previous year. And they anticipated upping the ante by 16 percent this year.

Major financial institutions have taken notice. Black­Rock, the world’s largest asset management firm, launched BlackRock Impact early this year to focus on impact investing. Prudential has committed an additional $1 billion to socially responsible businesses by 2020. And Bain Capital hired former Massachusetts Governor Deval Patrick last spring to found a new social impact investment business.

Impressive as this momentum appears, impact investments still represent less than one-half of 1 percent of the all the assets managed globally. As a movement some predict will replicate the success of venture capital, impact investing has a long way to go. And government can help by creating a more favorable regulatory environment.

That’s where the recent regulatory changes come into play. They remove barriers that have discouraged foundations and pension funds from seeking out impact investments. Today their stakes represent just 6 percent and 2 percent respectively of all impact investments, according to the J.P. Morgan-GIIN survey. Those figures are poised to increase.

On September 18, the IRS issued new guidance for foundations’ mission-related investments. Under the old rules, foundations worried that they would suffer tax penalties for making impact investments, especially those that produced returns below market rates. Henceforth, foundations are free to invest endowment assets in mission-driven organizations that align with the foundation’s charitable purpose. And they need not fear tax penalties if they choose to accept a lesser return from an investment with a strong mission component.

“In other words, a foundation can prioritize its mission over the demands of finance and need not fear tax consequences for taking risks or rates of return that other investors are less willing or unable to take—so long as this is done prudently, without placing the foundations ability to carry out its mission in jeopardy,” explained David Wood, director of the Initiative for Responsible Investment at the Harvard Kennedy School.

While it may take time for foundations to adjust to the new guidance, the effects on asset allocations could be enormous over the years ahead.

A month later, on October 22, Department of Labor (DOL) issued a bulletin rescinding a 2008 rule that subjected so-called economically targeted investments—aka impact investments—to extra scrutiny, all but eliminating them from consideration by pension fund managers. The change reverts to a 1994 rule stating that “fiduciaries may consider (social and environmental) goals as tie-breakers when choosing between investment alternatives that are otherwise equal with respect to return and risk over the appropriate time horizon.” In short, the ruling means that pension funds may invest in organizations with a social mission as long as the investment is financially prudent—the fundamental obligation pension fund fiduciaries. “Investing in the best interests of a retirement plan and in the growth of a community can go hand in hand,” said US Secretary of Labor Thomas E. Perez.

Even a relatively small percentage increase in pension fund impact investments would add up to billions in new capital. Funds governed by ERISA manage roughly half of the $18 trillion in US pension assets. But ERISA rules also have a powerful spillover effect on the trillions managed by state and local governments, and by religiously affiliated organizations.

The DOL bulletin also aimed to clarify that pension funds should consider factors potentially influencing risk and return, including social, environmental, and governance issues. Thus, these issues “are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.”

In Wood’s view, “This affirmation of (social, environmental, and governance issues) is just as newsworthy as the actual reversion to the 1994 guidance.” The change “acknowledges that (social, environmental, and governance) considerations are a fundamental part of the investment landscape.”

The steps taken by the IRS and the DOL are consistent with the recommendations of the National Advisory Board on Impact Investing and the Accelerating Impact Investing Initiative, a cross-sector coalition working to improve and expand the market for impact investments through changes to public policy. And there’s more public policy can, and should, do. For example, the National Advisory Board recommended that Congress provide tax incentives that modestly lower corporate tax rates for qualified impact businesses, lower capital gains rates for investors supporting qualified impact businesses, allow impact investors to write off losses as a charitable tax deduction, or allow individuals to deduct contributions to US impact initiatives.

Meanwhile, don’t expect the new guidance from the IRS and DOL to open the floodgates of foundation and pension investments. It will take years to develop new investment strategies and products that build on these changes. And obstacles remain, including lack of foundation and pension fund experience in evaluating and managing impact investments, and a dearth of investable opportunities.

But as venture capital pioneer Sir Ronald Cohen and Harvard Business School Professor William Sahlman wrote two years ago, “We believe we are on the threshold of a major change not unlike the early days of the modern venture capital industry.” The recent regulatory changes are significant steps in that direction.

By Michael Etzel (@etzel) is a manager in The Bridgespan Group’s Boston office. – See more at: http://ssir.org/articles/entry/new_regulations_boost_social_impact_investing#bio-footer