On November 3rd, the U.S. House of Representatives passed H.R. 2930 (the “Entrepreneur Access to Capital Act”), a crowdfunding bill that will allow startups to offer and sell securities via crowdfunding sites like Kickstarter and social networking sites like Facebook and Twitter. As I discussed in my post, “FAQ: What the new U.S. crowdfunding bill means for entrepreneurs,” this is a game-changer for startups and lifts certain securities law prohibitions that have been on the books since the 1930’s. Since I wrote that post, I have received numerous emails and phone calls regarding the House bill, which I will address below.
Has the House Bill Been Signed Into Law?
No, not yet. First the U.S. Senate must pass a crowdfunding bill. Then the House bill and the Senate bill must be reconciled in conference. The White House supports the House bill; thus, upon reconciliation, it will presumably be signed into law by President Obama.
Has a Crowdfunding Bill Been Introduced in the Senate?
Yes, on November 2nd, Senator Scott Brown of Massachusetts introduced S.1791 (the “Democratizing Access to Capital Act of 2011”), which was referred to the Committee on Banking, Housing, and Urban Affairs. A hearing was actually held by such Committee this morning with respect to a number of pieces of capital formation legislation, including crowdfunding.
Are There Any Differences Between the House Bill and the Senate Bill?
Yes, there are four significant differences:
- The Senate bill only permits the issuance of securities “through a crowdfunding intermediary” (like Kickstarter). Accordingly, startups would not be permitted to raise funds via social media sites like Facebook, Twitter or LinkedIn (as permitted under the House bill).
- Under the Senate bill, each investor is limited to investing up to $1,000 per year per company; the House bill permits an amount equal to the lesser of (i) $10,000 or (ii) 10% of the investor’s annual income.
- Similar to the House bill, the Senate bill caps the total amount of capital that may be raised during any twelve-month period at $1 million; the House bill, however, raises the cap to $2 million if the issuer provides potential investors with audited financial statements.
- Finally, the Senate bill permits some form of registration by the State in which the company is organized and/or “any State in which purchasers of 50 percent or greater of the aggregate amount of the issue are…residents.” The House bill preempts State law and, accordingly, there is no State registration requirement.
Has There Been Any Pushback to Crowdfunding?
Yes, the North American Securities Administrators Association (NASAA), a trade group for state regulators, has been lobbying very hard against the House Bill to prevent the preemption of State law and to reduce the maximum investment amount per investor. As NASAA President Jack Herstein wrote in a letter to House members: “Any effort to remove or weaken the up-front registration and disclosure process should not happen without adequate alternative safeguards….H.R. 2930 will create an exemption that will expose many more American families to potentially catastrophic financial harm.”
What Should Startups Do?
Until the crowdfunding bill becomes law, startups should avoid selling stock or other securities via crowdfunding sites or social networking sites. Why? Because such sales are in violation of applicable securities laws and thus could lead to severe consequences, including a right of rescission for the stockholders (i.e., the right to get their money back, plus interest), injunctive relief, fines and penalties, and possible criminal prosecution.
For example, as a recent Wall Street Journal article pointed out, the crowdfunding site Profounder “drew scrutiny from California securities regulators and was recently forced to abandon its original mission of providing online sales of equity stakes in small businesses.” Indeed, in August, the California Department of Corporations issued a formal consent order against ProFounder to “desist and refrain” from engaging in securities transactions without registering as a “broker dealer.”
Any company that raised funds via Profounder now runs the risk of having violated applicable federal and state securities laws by utilizing an unregistered broker-dealer.