November 15, 2011
I am writing with regard to "crowdfunding", to suggest a strategy of "radical transparency" as way to maximize disclosure while minimizing compliance costs. For example, allow the company to satisfy all requirements simply by posting its tax returns and cap table. Heck, if you feel the need, require it to post its bank statements and credit card bills, and whatever books it keeps, in whatever format it keeps them. Many small companies will feel that the competitive disadvantages of radical transparency are well worth the ability to raise capital without compliance costs.
In thinking about crowdfunding, I urge the SEC to focus not on helping companies with millions of dollars of assets or revenues, but on companies with double- or even single-digit thousands of dollars. The time in a business's life when equity finance is most needed is right at the beginning, in the first year of operations or even before operations have begun, and the companies that need it most are those founded by ordinary people with ordinary savings (the median net-worth for 35-44-year-olds is $51,575, according to http://cgi.money.cnn.com/tools/networth_ageincome/). I conjecture that the opportunity costs to America in terms of the startups that silently failed due to an inability to raise funding are larger than the (admittedly considerable) amount saved by preventing securities fraud.
In this situation, only small amounts of investment are needed, but many businesses just can't afford the costs of registration and reporting. The key is to craft regulation in a way that maximizes disclosure, while minimizing the necessity for the early stage business to purchase the services of lawyers and accountants.
I suggest the SEC consider "radical transparency" as a way for an early-stage company to disclose using documents that it already has to generate, without any additional need for lawyers and accountants at all.
I do believe that such investments are extremely risky, and care needs to be taken to educate the public about the speculative nature of early-stage companies -- perhaps statistics of similar investments should be included in any ads or prospectus, including mean and median returns, much like the idea of putting disgusting pictures of blackened lungs on cigarette cartons.
If there is still concern about this sort of proposal, I strongly suggest lowering the limit on individual investment below $10,000, instead of increasing the amount of disclosure in any way that increases the amount of expensive professional services required by an early-stage business. If Congress has already tied the SEC's hands by fixing the limit, perhaps the SEC could create an optional lower limit with looser disclosure requirements -- for example, if each individual only invests $100 or less, the disclosure requirements could become less.
Perhaps the SEC cannot resist asking just a few questions on a form. This is fine provided that neither a lawyer or accountant is needed to answer them (and that the penalties for screwing it up are not so severe that a lawyer will need to be hired to check it over "just in case"). The SEC should publicly set itself a target for the total compliance costs of these requirements (say, $2500 per year per business -- yes, this is a bold target), including professional legal advice, professional accounting advice, the average costs of defending any lawsuits provoked, and any other costs, and should carefully measure whether this target is being achieved. The SEC website should contain a single step-by-step document with everything a small business needs to know to disclose. Small businesses should not be required to keep abreast of changes to the law in any way besides visiting a single "What's New For Small Businesses" page on the SEC website once a year.