The long-delayed introduction of crowdfunding in the US takes effect on Monday, amid warnings that the new market will be choked by regulation and an attempt by Republican lawmakers to relax the rules.
A law change more than four years ago to open up investment in private companies beyond wealthy “accredited” investors was heralded as a breakthrough to allow anyone to back the next generation of tech start-ups. But a protracted review by the Securities and Exchange Commission delayed the new market, as regulators struggled with how to prevent fraud and money-laundering.
“The SEC has really created a credibility crisis for crowdfunding,” said Patrick McHenry, the Republican vice-chairman of the House financial services committee, in an interview with the Financial Times. “It’s as if regulators don’t have trust and confidence that this marketplace can work. It seems like they have no trust that we can successfully invest in each other.”
Financiers say complexity and uncertainty about the rules have discouraged many companies from trying to raise money at the outset, with some warning that the SEC’s regime will backfire on investors.
Only companies with no alternative would tolerate the cumbersome regulations, said Rory Eakin, founder of CircleUp, an online investment platform. As a result, the rules will lead to “adverse selection” that will leave only weaker companies using crowdfunding, he said.
The new rules require businesses to file accounts with the SEC that have been vetted by an independent accountant, and would force companies to go public once their revenues reach a certain size.
Tyler Gellasch, a former senior Senate aide and SEC official who worked on the legislation and the regulations, said the challenge was “finding the balance between unleashing the promise of crowdfunding and not opening the door for boiler rooms and drug traffickers”, said.
This has “unquestionably led to a more cautious approach than some in the crowdfunding world may have wanted”, he added.
Investment firms which back the new crowdfunding market also predict little interest at first, though they claim private companies will eventually grow more comfortable with the rules.
The market, which will allow private companies to raise up to $1m from the general public, will start “with a little bit of a whimper” but “could become a significant source of capital,” said Jim Dowd, of North Capital. “It will level the field a bit with venture capitalists.”
“It is going to be slow in the beginning mainly because of a lack of education among the issuers,” said Howard Marks, executive chairman of the crowdfunding platform StartEngine. “There have been a lot of naysayers and cynics, but the reality is that it is groundbreaking.”
Mr McHenry is pushing a bill that he said would tackle issues likely to make crowdfunding harder — including disclosure requirements that kick in when more than 500 investors are involved, and uncertainty over whether start-up investors can use special purpose vehicles..
“We had a roughly 10-page legislative text and they’ve written over 500 pages of regulation. I think that’s outsized and cumbersome,” he said.
The McHenry bill — which Kevin McCarthy, the House majority leader, has added to a broader package of innovation-oriented legislation — would also lift the limit on how much a single company can raise, to $5m from the $1m cap written into the original legislation.
Mary Jo White, the SEC’s chair, has said the crowdfunding law “sets forth detailed requirements for our rules”, limiting her agency’s room for manouevre. In a speech last week she welcomed input from investors and companies about how the requirements could be improved.
A number of crowdfunding platforms, including StartEngine and SeedInvest, say they plan to launch with a handful of companies on Monday. “It takes time to build experience and the understanding that finally you can raise money from the general public,” said Mr Marks.