Equity Crowdfunding Backers Clash Over Fundraising Limits in States
Frank Vinluan4/1/15Follow @frankvinluan
After five years of bootstrapping his startup, Instancy, Harvey Singh’s company has a finished education software product, revenue, and a growing roster of employees. As Singh looks overseas to expand Instancy’s sales reach, he says he is now ready for outside investors. He wants to raise that capital through crowdfunding.
The federal Jumpstart Our Business Startups Act made it possible for companies such as Raleigh, NC-based Instancy to sell equity stakes to the broader public, not just wealthy investors. Final federal crowdfunding guidelines are still forthcoming. But Singh, Instancy’s founder and CEO, worries that even when those rules are finalized, the federal legislation won’t be enough. The JOBS Act caps the amount a company can raise through crowdfunding at $1 million—not enough, Singh says, to scale his company.
“Any software company, or a biotech, $1 million is not really all that much these days,” Singh says.
So Singh is looking to see if state legislation might offer more fundraising flexibility. In the absence of federal crowdfunding rules, at least 14 states so far have passed their own rules establishing crowdfunding within their own borders. But in some states currently considering crowdfunding legislation, including North Carolina, the legislative debate is a tug of war over money. Some entrepreneurs and investors are pulling for higher caps, or none at all, on the amounts companies can raise. Lawmakers, seeking to protect investors, pull for fundraising and investing limits. Meanwhile, the Securities and Exchange Commission has made some rule changes that give startups more flexibility for raising money across state lines.
North Carolina initially introduced crowdfunding legislation, through debt or equity offerings, in 2013. That bill won overwhelming passage in the House, but an amendment-laden version of the bill failed to pass the Senate. Now the state is trying again. The new crowdfunding bill still mirrors the JOBS Act, but places oversight of crowdfunding under the securities division of the Department of the Secretary of State, explains Mark Easley, an angel investor and startup advisor who leads a private sector effort to support North Carolina’s crowdfunding bill.
The bills in the North Carolina House and Senate that Easley supports would limit companies to raising no more than $1 million every 12 months. But if companies provide investors with audited financial information, that cap rises to $2 million. Unaccredited investors, those who the SEC defines as having a net worth of less than $1 million and annual income of less than $200,000, could invest no more than $5,000 a year. A competing House bill would permit crowdfunding without limits on how much businesses could raise.
In most states that have passed or are considering crowdfunding legislation, the fundraising cap falls in the range of $1 million to $2 million. A Colorado bill would limit companies to $1 million per campaign. Massachusetts, which implemented intrastate crowdfunding by amending securities regulations, limits companies to $1 million in equity crowdfunding, or $2 million if companies make public audited financial statements.
New Mexico, which also implemented crowdfunding by amending existing regulations, permits up to $2.5 million per campaign. But New Mexico essentially allows unlimited crowdfunding becauseits rules permit multiple campaigns, explains Anthony Zeoli, a Chicago securities attorney who develops online crowdfunding portals.
Meanwhile, at the low end, Maryland and Oregon limit crowdfunding campaigns to $100,000 and $250,000, respectively.
Given the fees and legal expenses associated with setting up investment crowdfunding, Wilmington, NC-based angel investor Tom Vass believes the Maryland and Oregon fundraising caps make crowdfunding prohibitively expensive for companies in those states. Vass wants no limits on how much a company can raise, calling crowdfunding caps an unnecessary restriction on a company’s ability to grow.
“No public purpose is served by limiting the amount of capital a company can raise,” Vass says. “Companies need capital to grow. That’s what the public interest is.”
But Bill Warner, an angel investor and co-founder of EntreDot, a Research Triangle Park, NC,-based organization that supports entrepreneurs, says crowdfunding is intended for small businesses, not tech and biotech companies. It fills an investment gap for small businesses and seed-stage firms, which have the hardest time securing financing, he says. At that stage, Easley doubts most companies are seeking more than a few hundred thousand dollars. “If you’re a more mature company that needs $5 million, $10 million, you can get it, there’s other places,” he says, citing venture capital firms.
Instancy’s Singh has traveled the venture capital road before. As the co-founder of another e-learning software company, MindLever, he helped raise $5 million in venture capital to grow that company prior to its 2001 acquisition by Centra Software. In his search of $5 million for Instancy, Singh has made his case to venture capitalists. But he now sees venture capital firms narrowing their investments, choosing companies that have already hit certain revenue and customer benchmarks, which reduces a venture capitalist’s investment risk.
Singh adds that venture capitalists want to be close to their portfolio companies, which means that the dearth of VC firms in the Southeast compared to the Northeast and the West Coast puts a North Carolina company at a disadvantage. That’s why Singh supports intrastate crowdfunding and why he wants higher fundraising limits, or no cap at all.
State crowdfunding legislation won’t pass without a cap, says Zeoli, who was involved in the Illinois effort to write crowdfunding legislation this year. Though he pushed for no restrictions on how much companies could raise, he says his state’s lawmakers were unwilling to consider crowdfunding legislation without limits. Zeoli countered with a $20 million cap. Lawmakers settled on $4 million.
Despite the cap, Zeoli says companies still have crowdfunding options. A section of federal securities law permits companies to raise money from unaccredited investors in any state by offering up to $5 million in securities in any 12-month period. It’s rarely used. This “Regulation A” also requires companies to register these offerings in each state where securities are to be sold, making such offerings expensive.
But securities regulators last week approved rule changes in the JOBS Act that remove the requirement to register such offerings in each state. The “Regulation A+” changes also lift the fundraising ceiling to $50 million, enough for a “mini-IPO,” Zeoli says.
Zeoli still prefers that states don’t restrict how much companies can raise through intrastate crowdfunding. But he says companies can still crowdfund under the federal rules, as long as they’re willing to disclose more information and subject themselves to the regulatory scrutiny that comes with raising more money under Regulation A, and A+.
“You’re still getting access to money you didn’t have access to before,” Zeoli says. “If it’s not enough, it’s more than you had to begin with.”
