Crowdsourcing is an older sister concept embraced in recent years for raising donations from the general population.  Applied to equity investing, crowdsourcing practices run far afoul of established law, regulations, and vested interests. CROWDFUNDING - PAST, PRESENT, AND FUTURE
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The recently passed JOBS Act has created a beehive of chatter and hopeful activity in anticipation of revolutionary change to the ways small businesses can raise equity capital for growth or startups.  In this article, John C. Johnson provides a reality check on what may result, considering the promise, the, history, the present, and the future of regulation in this important space. 

June 12, 2012

John C. Johnson






The JOBS Act signed into law April 6, 2012, holds grand promise to unleash widespread matching of available capital to needs of small business for jobs creation.  The Act’s official name, contorted to fit the acronym, is Jumpstart Our Business Startups Act.  Its provisions set out to allow entrepreneurs to operate more effectively in helping to rekindle the economy.  It offers hope for revolutionizing the bottlenecks and monopolies that choke out broad flow of growth capital from the “haves” to the “needs”.

So-called “crowdfunding”, based on innovative concepts introduced by North Carolina Congressman Patrick McHenry, allows startups and small businesses to raise up to $1 million annually through a number of small-dollar donations using web-based crowdfunding platforms.  Crowdsourcing is an older sister concept embraced in recent years for raising donations from the general population.  Applied to equity investing, crowdsourcing practices run far afoul of established law, regulations, and vested interests.   One doesn’t look far to see clouds of protests from the entrenched players in the old system.

Progressively realigning regulation with modern technology is needed, to recognize and respect there is a better informed society, armed with fast communications, putting incredibly more information immediately at their fingertips and delivered readily into their living rooms.  Modernizing to reform regulatory impediments to nurture a vibrant economy by embracing crowdfunding, holds tremendous promise for spurring investment and jobs growth through flow of capital into small businesses.  Success is far from clear. 

Boots on the ground experience working as owners and advisors to midsized family businesses for the last 35 years made me a true believer in the societal value of small business, as well as the unfortunate limitations they face in working to succeed.  Traditionally, big government programs and solutions focus on big business needs relying on big finance and law lobbies for expertise, input, and outcomes that largely ignore, handicap or freeze out small enterprises and investors.  Disadvantages come as crippling prohibitions, regulation, and administrative costs, far beyond the reach of small players. 

Congressman McHenry’s creative proposal is vigorously applauded, as is the bipartisan decision to start encouraging and unleashing capital to small business to produce results for America.  Interesting how this is done, not with a financial subsidies, tax incentives, or some new entitlement program, but by opening the playing field a little bit to let the economy and technology work.  If anyone can and will create jobs, it is small business, not government, labor, or entitlements block voters.

According to the US Small Business Administration (SBA), small firms make up 99 percent of employer firms, employ half of all private sector workers, and accounted for 65 percent of new net jobs created between 1993 and 2009.  From 2005 through 2007, starts of employer firms outpaced closings by about 80,000 firms per year, this reversed to negative 36,000 in 2008 and 110,000 in 2009.  Small business is placed squarely among 99% of the “folk”. 

Historically, access to growth capital has been highly restricted for small business.  This has been exacerbated in recent years as SBA tightened underwriting protocols, just as commercial banks lost their appetite for loans they would have funded quickly, pre-2009.  Small firms must typically look to their owners and commercial banks for growth capital, while start ups are most often funded out of an owner’s pocket, credit cards, or from friends and family.  The outside world of equity investors has remained forbidden fruit.

The Congressional intent and mandate for visionary opening of capital markets gives cause for celebration, encouragement and hope.  Hope is to see crippling regulatory handicaps against small businesses and investors materially reduced, even in the face of entrenched regulatory schemes, institutionally protected interests, and reality that fraud potential is ever present wherever money flows. Hope is for change bringing much improved balance between securities protections and the grand potential of freeing the market to allow prolific linking of small stake capital investors with entrepreneurial needs.  But what is the realistic future of this?  First, we must consider the past.


For almost 80 years, it has been difficult to impossible (i.e., unlawful) for small businesses, legitimately needing growth capital, to broadly reach out to generally advertise to and solicit the universe of possible investors.  Investors who might very well want to invest in these businesses and take a business risk to achieve handsome returns. 

In 1852, “Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, by Mackay” chronicled the delusional phenomenon of crowd attraction to perceived opportunity, leading to disastrous endings.  Mackay described the madness back to the alchemists’ promises of making gold from lead, up through the Tulipmania, The South Sea Bubble, and John Law’s Mississippi Scheme.  The bubbles, manias, and schemes range from financial hysteria to healing, fortune telling, witchcraft and the influence of religion on hair and beards.

Some in clandestine companies combine;
Erect new stocks to trade beyond the line;
With air and empty names beguile the town,
And raise new credits first, then cry 'em down;
Divide the empty nothing into shares,
And set the crowd together by the ears. - Defoe

Widespread abuses and fraud prevailed when promoters sold “pieces of the Bluesky” to feed upon greed of an unwary and uninformed public in the early part of the last century.  Problems were obvious in boom and bust schemes.  Early investors attracted others to pour in behind, hoping to capture a hot deal sold with a slick spiel, only to lose their shirts when the fairy dust ran out.  This was perceived to have influenced the stock market crash of 1929 leading to the Great Depression, precipitating the Federal Securities Act of 1933 and others to follow.  Interesting how, despite worthy protective intentions, we still experience problems of age old patterns.

“Money, again, has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper. . . .  Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”  Mackay 1852

Securities law and regulation set out to ensure securities buyers receive full and accurate information before they decide to invest.  Securities and Exchange Commission (SEC) staffers cite their need to “protect investors”.  As in many behemoths, the devil is not in the lofty mission or good people charged with implementation, but in unintended consequences or unfortunate collateral damage.  Unreasonably limiting a family owned business’s ability to obtain competent assistance in selling their business, optimize structure, and access the full breadth of the buyer market is one of these.  Another is effectively squelching capability of a “common man” to seek out investment funding from like people seeking to invest funds.


From a small investor and business perspective, the securities regulatory scheme is a massive obstacle and monopoly rigged for the big players to thrive.  It defacto excludes or severely limits full access to markets and service providers for the vast majority of businesses needing to sell their business or attract small equity investors.  Big players hold all the seats at the table.  They are the SEC, well-heeled investors, top shelf lawyers and accountants, Wall Street type investment bankers, broker/dealer firms whose regulatory compliance burdens start at about $100,000 per year.  The full market access goes to rich investors and companies enjoying financial wherewithal to ante tens of thousands to millions of dollars and possibly sacrifice vital confidentiality, just to find out if they might land buyers or investors.   Cheating smaller players out of cost appropriate opportunities to sit together at a table right sized for them is not the intent of the regulators; it is just how the rules work out.


One huge restriction on democratic access of plebian investors to plebian investments is prohibition on general solicitation; access to private investors is generally restricted to ones with whom there is a substantial pre-existing relationship.  It’s a little like a professional buddy system.  Other great investors outside the loop for a deal are out in the cold.  A second freeze out is because offerings permitting lower regulatory burdens, such as Rule-506 private placements are restricted to “accredited” investors.  This follows the regulatory belief the well-heeled are sophisticated enough to protect themselves.   Regulators quip they are there to protect widows and orphans from the bad actors.   It is no stretch to comprehend that far fewer widows and orphans are saved from scams than the huge numbers of astute less-heeled investors and small firms in need of equity, who are regulated right out of the means to find and work with one another in broad scope.  


The net?  Toll booths are manned by people already in the game, and the tolls and are huge for a plebe.  In the interest of trying to prevent defrocking the unwary via securities fraud, regulations practically deny untold billions of dollars of capital to small business with corresponding untold jobs going uncreated due to highly limited vehicles for investors to discover the universe of opportunities, then make their own investment decisions from the broadest selection.


In regulators’ eyes, costs, burdens, delays, and exclusions caused by their rules are not central concerns.  They may be empathetic or sympathetic, but are not much moved by these factors.  They, of attorney and bureaucratic cultures, are not charged with making it easy, efficient, inexpensive, or fair.  The people denied access to investments or needed equity, due to the economic burdens or regulatory restrictions are out of sight and out of mind.  The regulators’ fervor, and legal charge, is protecting investors from acting on bad information, thereby preventing bad actors from clipping naïve investors.




Two JOBS Act provisions modernize and impose revolutionary change to crack the door to world wide access for matching available capital to needs to raise equity, and propel growth of small businesses and jobs.  Wide ranging communications of interests are to be allowed by the likes of the Internet, advertising, and tweets, of all things!  Imagine the novel concept of seeing unregistered securities advertised in the media; gone are admonitions to restrict upcoming stock offerings communications to written materials.  Another electronic blow delivered to the Post Office and the printing industry.


The Act mandates allowing use of general solicitation and advertising in Rule 506 private placements.  A second provision allows a new offering class, exempt from registration and accredited investor requirements for crowdfunding of up to $1 million in equity.


A mere forty-five days after JOBS Act passage, crowdfunding opportunities are on a torrid pace into the market, hosting sites are proliferating, and blogs have gone wild.  Googling “crowdfunding” already returns over 7 million hits versus 6 million searching for the 80 year old “private placement”. 


Let the dancing begin and the pent up pleas for investment fly into cyberspace!   No?  Hold on?  Whoa?  What?  Not so Fast!





Today, nothing has changed except the future.   Don’t hold your breath.  Visibility into that future is foggier than pea soup.  General solicitation prohibitions remain unchanged and crowdfunding is prohibited, until the SEC writes new enabling rules.  Look into the implications of running afoul of SEC rules to understand, it can be a costly mistake.  So what can be expected?


Expect the worst, hope for the best, and celebrate the possibilities as we bide time for the rest of 2012.


The legislation itself has requirements to govern the amount of regulatory slackening.


While Rule 506 offerings are to be released from prohibitions on general solicitation, the release restricts actual sales to the well-heeled class, known by the affectionate moniker “accredited investors”.   So, subject to new SEC rules, once again only well-heeled investors may buy as a result of being sent advertising on offerings.  Even with the accredited investor restriction, this should radically improve the ability to reach and match willing partners. 


Crowdfunding is based on a notion of allowing small businesses to reach out to be discovered by the largest number of potential equity buyers, who can then self select participation.   This brave new world has the potential to efficiently take investments into the market with minimal obstacles. The Act provides various requirements including offerings are of restricted stock, sold through registered intermediaries, transacted through registered portals, under the authority of an SEC approved Self Regulating Organization (SRO), and subject to a substantial laundry list of administrative, qualifying, disclosure and record keeping burdens. 


So far, so good.  Soon, small business can raise capital in small amounts from investors sourced broadly through Internet or other communications.  Impediments number one to the pots of gold; a registered intermediary and a registered portal can be expected to be expensive toll roads with big fines for mistakes.  Better get a good attorney in addition to your registered broker working the registered portal, to be fronted and followed by substantial administrative and preparatory obligations.  This will not mirror crowdsourcing donations, where solicitors write a story, state their need, pop up a video, offer rewards for donating, and see if the cash comes rolling in.


A problem can be seen coming around the bend.  One attorney states the JOBS Act is the most significant deregulation in the lifespan of the SEC, and it was achieved over substantial SEC objection. The bill passed in the House then was throttled back by the Senate, following significant lobbying by statist public protectors, such as the SEC.   The Jobs Act mandates do not become effective until the SEC writes new rules. 


Given an entrenched way of operating at the SEC and their objections during crafting of the JOBS Act, there is real potential the rules to come may strangle the big opportunity to open markets to small players, and keep tight controls in the hands of established big money players.  It is hard to envision the SEC boldly expanding the box to creatively fashion decent investor protections yet enable small participants a cost efficient path to broad markets.  The nature of behemoths is to favor risk free moves at the expense of bold improvement.  Similarly there is precedent of following structure over substance and rules over reason.  It will be interesting to watch this unfold and see if the SEC musters the will to adhere to the spirit of the JOBS Act mandates.  Minimizing cost of compliance is not customarily among the prime factors in SEC rules.  Access by small players has never before been a priority, except as a protected species.


The SEC has the ability to write rules that help bring vastly improved capital access while maintaining decent protections to investors, or the ability to write restrictions to drive all the opportunity right back to the big money vested interests.  Slow, bureaucratic, risky, and expensive compliance, and small business participation are not compatible.


Two extreme outcomes loom likely.  One is to open up the rule making mindset to find the most creative ways to implement the law with the fewest possible impediments and cost efficient, reasonable protections to investors.  The other is to make rules to channel potential benefits to a privileged few. 


Stay tuned and don’t jump the gun.



John C. Johnson is an advisor and advocate for midsized private and family businesses.  He served as President of the International Business Brokers Association and The M&A Source.  He is a respected business community leader and trusted business intermediary since 1987.  His firm, BluestemUSA, can be found at


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