Last week the House Subcommittee on Capital Markets, part of the powerful House Financial Services Committee, debated several important bills that may boost access to capital for SMEs. One of the bills, the Fix Crowdfunding Act (HR 4855), has the profound potential to turn Title III crowdfunding (Reg CF) into something quite powerful by addressing several shortcomings prescribed in existing rules. But probably the most important aspect of the Fix Crowdfunding Act is the fact that it will incorporate significant changes that will dramatically enhance investor protection while providing improved opportunity for smaller investors to generate wealth.
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.
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.