April 12, 2012
The Patrick McHenry predecessor (H.R. 2930) had preempted state-by-state blue sky laws, eliminating the costly start-up filing, legal, accounting and auditing fees often associated with public offerings.
The Senate bill preempts state laws, too, but then H.R. 3606 creates a whole new federal requirement — for the very reviewed and audited financial statements once provided for under state law. This time, companies attempting to raise more than $100,000 must be reviewed by public accountants, and more than $500,000 fully audited.
According to Goingpublic.us, the cost of direct public offerings can range anywhere from $40,000 to $100,000, or even be as high as $1 million, depending on the complexity of each transaction. The bulk of those fees are directly related to accounting and auditing requirements.
So, that means a new business seeking to raise just $500,000 in capital through crowdfunding to produce, say, video games, will have to first incur an up-front cost of tens if not hundreds of thousands of dollars in fees.
Except, businesses typically attracted to crowdfunding venues like Kickstarter.com and Indiegogo.com often do not have any capital to speak of, let alone $40,000 to $100,000 to spend on lawyers and accountants. In many cases, they are brand new companies with no revenues or assets, so there will be very little to audit or account for. It is something of a superfluous requirement for many start-ups.
But worse, it creates a catch-22: to raise capital on the Internet, the company first needs a pile of money to meet the regulatory requirements. This is one of the reasons why the number of IPO's has dwindled in recent years.
So, start-ups may be back right where they started. Thanks to the rush to regulate in this new area of capital creation, Congress may have inadvertently defeated the entire purpose of the crowdfunding provision of the law. In part, this shows some lawmakers' ignorance of what crowdfunding even is.
A relatively new phenomenon, crowdfunding operates with small businesses raising small-dollar contributions from a large number of people, typically on the Internet. Web companies like Kickstarter.com have helped raise more than $100 million since it launched in 2009 for non-profits, low-budget film productions, video games, and other projects.
Slava Rubin, founder and CEO of Indiegogo, has said he intends to file to become a funding portal under the new law. "Well be able offer for-profit equity investments Small businesses need to find a way of getting capital right now," he said in an interview with Portfolio.com.
For now, individuals who pledge money to projects are enticed with rewards upon completion, such as a DVD or the video game itself, but cannot gain a stake in the company. These projects are already being funded without any complex scheme of mandatory accounting and auditing. And despite there being no mountain of regulations, funded projects are typically completed without complaint.
"If we had a lot of fraud going on wed be out of business," Rubin noted.
Why Congress felt the need to include such onerous and costly requirements is anyones guess, but they now present a challenge to crowdfunding venues that would still like to cater to start-up companies that simply dont have the money to pay for the mandatory accounting and auditing.
Heres a suggestion for the SEC. Allow crowdfunding portals like Indiegogo or Kickstarter to cover the accounting and auditing costs by either hiring or contracting out those services to a third party, and then folding the costs into the price of using the funding portal. Create a specific process for this. That way, crowdfunding portals can still attract new and upcoming entrepreneurs and the intent of the law be realized.
If done on a large scale, these fees can be made affordable (think: LegalZoom.com), and give these crowdfunding venues an edge over some of their Wall Street competitors that were charging tens of thousands for such services -- a barrier to entry for new start-ups.
Despite some of the redtape created by H.R. 3606, Congress is to be praised for their efforts to help raise unrestricted capital on the Internet. This may yet help free up some $6 trillion in savings to be used readily in investments, and potentially create millions of jobs.
But now the hard work begins for the SEC and crowdfunding portals to cut through the red tape, and make certain it is still accessible to new businesses that have no capital, just the next big idea.