Popularity of Crowdfunding Urges Changes to SEC Regulations

Apr 07, 2010 · 2 mins read
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Crowdfunding sites, like Kickstarter, have been in the news a lot lately. Their success in raising money for creative projects is well documented.
Currently, crowdfunding projects have been limited to donations, primarily for specific creative endeavors. Donations can be rewarded with perks and products, but using crowdfunding to raise business capital that would offer an actual return on investment is another matter entirely.

Regulatory Restrictions

While crowdfunding to raise venture capital is not illegal, it is prohibitive due to current Securities and Exchange Commission (SEC) regulations. The issue involves the sheer number of people necessary to make crowdfunding succesful. Crowdfunding works on the premise of raising necessary finances by collecting small amounts, sometimes as little as $5, from a large number of people.

According to SEC Regulation D, Ruling 505 and Ruling 506, which was written in the 1930’s, companies with more than 35 regular investors must file cumbersome reports with the agency. Legal fees and other expenses affiliated with filing the paperwork amount to costs too excessive to make it beneficial for those raising capital a few dollars at a time.

Petition for Change

There is currently a growing movement to change the SEC rules. Startup Exemption is one group formally lobbying to get the decades-old law changed. As of today, the group’s “Petition to Encourage Investment in Startups and Small Businesses” has 1,675 signatures.

With the phenomenal success of social media sites, like Facebook and Twitter, small businesses actually now have the ability to solicit small dollar investments to a wide audience.

Believing that the ruling is hindering the potential growth of small businesses in America as banks and other more traditional venture capitalists tighten the reins on the money available to startups and entrepreneurs. According to the group’s blogsite, it will be taking its proposal for change to Capitol Hill on May 10, 2011.

The most popular proposal for change appears to be one for allowing crowdfunding financing of startup capital up to $100,000 without requiring SEC report filings.

Argument for Status Quo

The initiative to change the SEC rules, however, is not without its opponents as well. The opposing view is most often based on the idea that the SEC rules protect investors from unscrupulous businessmen.

There is actually precedent that warrants such concern. In 1992, the SEC began allowing small businesses to issue up to $1 million worth of common shares to regular investors without having to comply with full financial disclosures and other regulatory requirements of existing rulings. By 1999, serious concerns over fraudulent activity caused the SEC to rescind the 1992 regulatory change.

Of course, one benefit of crowdfunding for venture capital is that the investment is small and so the investor’s exposure to risk is also low.