Crowd Fund Investing,

Reversing the Decline in Capital Formation

Startups and Small Businesses are a critical part of our economy. They provide the majority of new jobs and salaries that are used to purchase goods (food, gas, rent), and stimulate the economy. However, Startups and Small Businesses need cash to fund their businesses and hire Americans. With the financial meltdown, the traditional means of business financing (bank loans, credit cards and venture capital) are no longer available to 98% of businesses because banks are holding on to their cash, credit card interest rates are exorbitant and private capital is only available to a select few. Without access to cash, thousands of businesses in 2011 will not start or grow and that means fewer jobs and a weaker US economy.

There is a solution. It is called crowd funding – regular Americans, choosing to invest small amounts of money in small businesses in their communities. However the SEC doesn’t allow the average American to invest at all because of regulations written almost 80 years ago.

Read on to learn about proposed commonsense modifications that the SEC should make to these regulations to provide a reasonable level of investor protection (anti-fraud & transparency) while easing the restrictions so that capital can flow to startups and small businesses from individuals who want to invest small amounts of money in them.

Reform to Allow Micro-Angel Investors

Entrepreneur Sherwood Neiss created this testimony for the House Committee on Oversight and Government Reform, United States House of Representatives.

Crowd Fund Investing (CFI) is not permitted by securities laws today but it stands to be a powerful method of financing, where groups of people will come together to invest in startups and provide valuable knowledge and experience to help an entrepreneur succeed. It will provide a way for unaccredited investors to pool their individual small contributions (likely between $50 – $500 each), and invest in companies and entrepreneurs they believe in. The funding rounds will occur on Internet platforms, which provide an added level of transparency and communication between the investors and the entrepreneurs. And “Micro-Angel Investors” will support people and businesses they believe in and in turn, help to grow the economy.

In order to make this a reality, we support creating common sense modifications to existing regulations to enable small businesses to raise capital. These reforms are modest, follow the spirit of the Securities Act of 1933 and the Exchange Act of 1934 and include:

1. Strong anti-fraud provisions
2. Limited risk and exposure for unaccredited investors
3. Transparency
4. Standards-based reporting and a
5. Limit to the amount of seed capital a company can raise

StartUp Exemption Framework

• We propose the creation of a “funding window of up to $lM” for entrepreneurs and small businesses. (“Small Business” will be defined as one with average annual gross revenue of less than $5M during the last three years or since incorporation if the business has existed for less than three years. This definition will be consistent with definitions utilized by the Small Business Administration).

• Where any individual (including unaccredited investors) can choose to invest; however investments from unaccredited investors would be limited to $10,000. (The $10,000 limit is in line with other established financial disclosure limits like those on banking transfer reporting requirements. That said, based on what is happening on Crowd Funding websites today (to be further explained below), we anticipate that the majority of individuals making Crowd Fund Investments will be below $500 each).

• Investors will have to complete a questionnaire to determine their aptitude to participate in Crowd Fund Investing and answer a series of disclosures that demonstrate they have prior experience with making investments and/or are familiar with the principles of investing and associated risks. (These safeguards provide investor protections so that Crowd Fund Investing is on par with the level of risk for other investments of this class (e.g. publically traded penny stocks)).

– Eliminate the SOO-investor limit and the broker/dealer licensing requirements for Crowd Fund Investing via this window.

– Exempt these offerings from state law registration requirements based on the limited size of the amount that can be raised, but leave intact applicable state law notice filing requirements, similar to the way SEC Rule 506 currently works.

– Allow for general solicitation on registered platforms where individuals, companies and investors can meet virtually, ideas can be vetted by the community as sort of peer review, informed decision can be made on whether or not to invest their money and crowd fund investing can take place. These platforms would provide standards-based reporting to the SEC on the entrepreneurs and small businesses utilizing the platform.

– Standardized and automated forms and procedures would be used for these financing offerings to reduce time and expense for all parties while maintaining transparency.

A similar framework is already in place in the U.K., Holland, India and China. Now is the time to make this happen in the U.S. so our economy is not left behind. We believe this framework is one that will allow for transparency, accountability, limited risk and exposure and the flow of capital.

Related Sites / Articles

Sign the Petition to Support Crowd Funding on the Startup Exemption website

Improving the landscape for organic startups

View the May 10, 2011 hearing:

“The Future of Capital Formation, Panel 1” (1:35:55)

“The Future of Capital Formation, Panel 2” (1:06:49)