By GREGORY ZELLER //
Seven years after a new federal law attempted to kickstart the startup market, investors and entrepreneurs are still finding their way – but a few key legislative tweaks could open the equity-crowdfunding floodgates.
That’s the from-the-trenches assessment of Alon Kapen, a partner at Uniondale-based Farrell Fritz and head of the firm’s Emerging Companies & Venture Capital practice group, who recalls the Jumpstart Our Business Startups Act of 2012 – a blessedly bipartisan, Obama-era B12 shot for small-business investors – as a turning point in crowdfunding history.
Unfortunately, the JOBS Act – “nothing to do with job creation,” Kapen notes – has evolved in fits and starts.
It meets its primary objective by easing securities regulations that previously excluded most would-be U.S. small-business investors, and that’s meant the world to crowdfunding platforms like Kickstarter and Indiegogo.
But the capital-raising reformation hasn’t fanned startup flames to its fullest potential, according to Kapen, who basically likes the “three flavors” of equity-crowdfunding options scooped into the JOBS Act – he just wants the cherry on top.
“There is some data, and my personal view is the outcomes are a little disappointing,” Kapen told Innovate LI. “The current regulatory regime isn’t nurturing the development of the equity crowdfunding market.
“Some of the rules are overly burdensome,” he added. “But there are efforts to reform the rules, particularly Title III.”
Before we get into titles, flashback: Kapen recalls a pre-April 2012 hellscape in which startups could only raise capital through public offerings or private placements – and were prohibited from soliciting investors, or advertising their offers, and those private placements were limited to “accredited investors.”
That’s federal code for “rich people,” Kapen noted, citing an SEC “income test” requiring minimum $200,000 income for two years, net worth exceeding $1 million (primary residence excluded) and other strict qualifications.
That immediately excludes 93 percent of Americans, who despite their meager existence still manage to squirrel away some $30 trillion in savings. Cutting them out somewhat dampened the investor market, according to Kapen, who lamented further investor restrictions placed on the pre-approved 7 percent.
“Since you were prohibited from generally soliciting and these were supposed to be private offerings, that meant you could only sell to people with whom you had a preexisting relationship,” he said. “Imagine how difficult it is to convince an investor to invest in your company now – add on top a restriction that you can only sell to people with whom you have a preexisting relationship.”
There were allowances, but entrepreneurs selling business equity to friends and family were “taking a risk,” Kapen added. “It was always unclear whether you fell within an exemption.”
With its “three flavors of equity crowdfunding” – known officially as Titles II, III and IV – the JOBS Act “changed all that,” according to the corporate attorney, or at least tried to.
Title II allows entrepreneurs to engage in general solicitation – they can tell everyone about their widget and ask them to buy in. But they can only deal with “accredited investors,” and when money’s on the table, the onus of accreditation now falls on the entrepreneur.
Title III generated most of the JOBS Act buzz, according to Kapen, essentially establishing that business owners could raise up to $1 million (per 12-month period) with a host of scaled-down SEC disclosure requirements – and they could do it over the Internet. The 12-month limit has since been raised to $1.07 million.
Title IV revived an old staple of capital-investment law, known as “Regulation A.” Revamped (with higher investment caps and less state-level regulation) and rolled into the JOBS Act (with the affectionate nickname “Regulation A-Plus”), Title IV established what’s come to be known as the “mini IPO,” a chance for first-time public companies to raise up to $50 million in a single year – again, with minimized SEC oversight.
“It’s not easy or inexpensive,” Kapen noted. “It does require that you lawyer up and you do engage in an SEC review.
“But the SEC wants this market to happen,” he added. “It wants it to be successful. So, relatively speaking, the SEC is going easy on Regulation A-Plus filings during the review process.”
The three flavors are changing investor tastes – crowdfunding success stories abound – but “the market is still relatively new,” according to Kapen, “and it still needs time to mature before outcomes become clear.”
What will help, according to the longtime advocate for capital-markets reform, are a few adjustments: raising that Title III cap to $5 million, allowing for “special purpose vehicles” (group funds, essentially) in crowdfunding deals, new “testing the waters” protocols that would allow fledgling companies to make offers and solicit responses, without making any actual deals – a great tool for gauging investor and market interest, according to Kapen.
Whether those changes are coming soon, however, is unclear. Some legislative amendments have died in committee, some have passed the House but not the Senate – none has scored, and right now, the prospects for significant change seem bleak, at least anytime soon.
“There are other things considered more pressing for Congress,” Kapen said. “And Congress isn’t doing much of anything these days.”
The possibility of reform and the fate of the capital markets moving forward will be front and center Feb. 7, when Kapen leads an Equity Crowdfunding Workshop at Stony Brook University’s Long Island High Technology Business Incubator. Approached by SBU’s Center for Biotechnology to preside over the workshop, the attorney plans to discuss key considerations for companies considering crowdfunding, including costs, benefits and drawbacks.
“The event will inform academic entrepreneurs and others about the options for bringing a company online with these non-traditional offerings,” he said. “A taste of the different flavors.”
Even with federal gridlock slowing the evolution of the American startups market, things are still sweeter now than they were seven years ago, Kapen noted.
“The No. 1 takeaway is that the Internet has come to the capital-raising industry,” he said. “Think about what happens when the Internet comes to any industry. The publishing industry, travel, dating – it creates efficiencies, it brings buyers and sellers directly together, it basically disrupts the entire industry.
“This will have the same effect on capital-raising,” Kapen added. “Theoretically, the Internet levels the playing field.”