Despite political giddiness, ignore crowdfunding finance

In November, the House of Representatives passed the Entrepreneur Access to Capital Act (H.R. 2930) which will make it easier for businesses to raise capital through “crowdfunding”. The legislation would amend the Securities Act of 1933 by providing a new securities registration exemption by allowing companies to raise up to $1 million within a 12-month period, or up to $2 million, if investors are presented with audited financials. These securities would not need to be registered with the Securities and Exchange Commission (SEC). The exemption would limit investments to the lesser of $10,000, or 10% of the investor’s annual income.

Companies relying on the exemption, and crowdfunding websites retained to facilitate the offering, would be required to make only limited disclosures to potential investors, including (i) the goal amount of the offering, and (ii) a warning about the speculative nature of the offering.

People who have been convicted of securities fraud or other financial crimes will be prohibited from raising money through crowdfunding. Companies and their intermediaries must deposit any invested funds with a third party to hold until the company raises at least 60% of the goal amount. Investors purchasing securities in these offerings would be locked up for one year from reselling their securities (except back to the company or to accredited investors). Offerings would also be exempt from state blue sky registration requirements, thus preventing states from issuing more restrictive rules.

H.R. 2930 passed with a huge bipartisan majority. President Obama actively supports this concept, and indicated the legislation will be signed. Two crowdfunding bills are introduced in the Senate: the Democratizing Access to Capital Act (S. 1791), and the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act (S. 1970, also referred to as the CROWDFUND Act. The possibility is quite high that some form of this legislation will be passes this year.

Once they become available, I suggest that any investor interested in capital preservation forget these offerings. While the loosened requirements make popular politics for “job creation”, the risks of fraud and economic failings with these small companies is too great.

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