An Opportunity to Fix Crowdfunding Before It Falters

Photo credit: LendingMemo.com

Photo credit: LendingMemo.com

This post originally appeared in The Hill.

On May 16, 2016, regulation crowdfunding will go into effect, meaning for the first time ever,anyone can invest in a startup through an online platform. This is big. Until Congress passed the JOBS Act  in 2012, buying an equity stake in a company required being fairly wealthy or having a pre-existing relationship with the entrepreneurs raising capital. But the Internet has dramatically changed the way entrepreneurs share their ideas and connect with potential investors. With the JOBS Act, the law finally caught up as well – or it almost did.

After the the JOBS Act’s passage in 2012, the Securities and Exchange Commission was tasked with crafting the regulatory framework for equity crowdfunding. The agency at long last finalized the governing rules in October 2015, but many of the new requirements will make crowdfunding a costly and inconvenient endeavor for startups. Thankfully, members of Congress have already proposed a solution to address these issues, the Fix Crowdfunding Act.

The Fix Crowdfunding Act, sponsored by Rep. Patrick McHenry (R-NC), would implement a number of fixes that would significantly improve this new funding mechanism. First, it would first increase the annual funding limits for issuers from $1 million to $5 million, a sensible change Engine has previously advocated for. $1 million is an arbitrary limit that does not accurately reflect startups’ actual capital needs.

The proposed bill would also allow for special purpose vehicles (SPVs) to raise capital through regulation crowdfunding, a practice already in use in the U.K. and in the accredited investor space here in the U.S. By pooling together funds from multiple investors, SPVs could help nonaccredited investors better diversify their portfolios and could consequently make investment crowdfunding safer and more profitable for investors.

Finally, the Fix Crowdfunding Act includes an important “testing the waters” provision, allowing startups to lawfully communicate with potential investors and gauge interest in their offerings before committing the time and incurring any of the burdensome filing and preparation costs required under current rules. Since around one third of rewards-based crowdfunding projects fail to meet their funding goals, allowing companies to evaluate whether they are likely to succeed or fail before spending valuable resources preparing a campaign is critical to making crowdfunding effective and efficient for startups.

With each of these provisions, the Fix Crowdfunding Act makes regulation crowdfunding more attractive to issuers. Appealing to more issuers, especially to quality companies, is essential to the overall health and stability of the crowdfunding market in the long term. If crowdfunding is simply too expensive and too onerous for issuers to bother, they’re likely to rely on Regulation D instead—a far simpler capital-raising option that’s limited to wealthy accredited investors. If the best companies find capital elsewhere, only startups without a shot at raising funds from more established investors will choose to crowdfund, establishing a risky foundation for a brand new market and for first-time investors.

Through several reasonable provisions that reflect realities in the market, the Fix Crowdfunding Act will help make regulation crowdfunding a more viable fundraising option for startups. We urge Congress to pass this legislation and ensure the newest generation of startups and investors eager to utilize crowdfunding are afforded a system that sets them up to succeed.