Q&A with Kendall Almerico on Title III equity crowdfunding rules
Kendall Almerico has been one of the most vocal proponents of equity crowdfunding and the JOBS Act for the past three years. In addition to launching Bankroll, a funding platform for Regulation A+ Mini-IPOs the day that portion of the JOBS Act went into effect, Kendall’s law practice is centered on advising and providing legal services related to all forms of crowdfunding. We reached out to Kendall to find out his take on the just-released Title III equity crowdfunding rules.
Now that you have had a chance to read the SEC equity crowdfunding rules released last week, what are the biggest surprises?
There are 686 pages of SEC rules for this nine-page law, so you can imagine there are some hidden gems in there. The good news is, the SEC took away the audit requirement for first time users of the law, so now anyone using equity crowdfunding to raise from $100,000 to $1 million only needs “reviewed” financials, which is far less costly. Under their proposed rules, anyone who wanted to raise more than $500,000 would have had to have fully audited financials, which would have priced almost any startup out of the market. And, equally important, the SEC did away with one proposed provision that would have given new funding portals little to no discretion to turn away anyone who wanted to try crowdfunding on their site. So now, if Bernie Madoff comes along from his jail cell and tries to crowdfund on a new portal, the portal can tell him no.
With the removal of the audit requirement, will the law be affordable for businesses to use?
It depends. For people who think this will be just like pre-selling a new smart watch on Kickstarter, they will have some surprises coming. Equity crowdfunding involves the sale of securities. There are state and federal laws to comply with, and bad things can happen to people who ignore those laws. By bad things I mean lawsuits and even possibly jail time, if you do this wrong. So there will still need to be lawyers, accountants and other professionals involved, and those cost money, even if they are entrepreneurial like myself and are willing to get creative with fees at times. The law is still going to be difficult for people to use effectively is they are only looking to raise $100,000 or less.
What do you see as the biggest cost? Legal? Accounting?
Surprisingly to most, I think people will find that the legal and accounting costs will be minor compared to the one crowdfunding expense very few people talk about: marketing. Why do less than four percent of successful Kickstarter campaigns raise more than $100,000? Because very few spend the marketing dollars to make a crowdfunding campaign work. Most Kickstarter and Indiegogo campaigns that raise money the six-figure and seven-figure range spend tens of thousands of dollars in marketing to get to that level. The same will be true for equity crowdfunding. And, based on one provision in these new SEC rules, it could cost even more in marketing dollars to be successful.
What is that provision?
One of the well-know keys to effective rewards-based crowdfunding is marketing the campaign on social media, where people share the crowdfunding campaign with their friends and followers, creating a viral buzz that drives people and donations to the campaign. While the SEC rules allow social media marketing of equity crowdfunding campaigns, the rules place handcuffs on businesses by limiting social media marketing of the crowdfunding campaign mostly to basic information like the name and address of the company, terms of the offering, a link to the campaign and other details that will not likely be widely shared online. Limiting companies to market with boring “tombstone ads” will hamper the viral nature of crowdfunding from taking effect. It’s hard to get excited about a tombstone, and who wants to share something boring on social media? As a result, companies will have to turn to more expensive methods of marketing, like hiring PR firms and other consultants.
Any other surprises in the SEC rules?
One big surprise to me was that the SEC actually tightened the amount of money anyone can invest in an equity crowdfunding campaign. Under the final rules, an investor will be limited to investing the greater of $2,000 or five percent of the lesser of the investor’s annual income or net worth if either annual income or net worth is less than $100,000 or 10 percent of the lesser of the investor’s annual income or net worth, not to exceed a maximum of $100,000, if both annual income and net worth are $100,000 or more. Under the proposed rules, an investor could invest based on the greater of the two factors, not the lesser.
Confused? Look at this example. An investor with annual income of $50,000 a year and $105,000 in net worth will be subject to an investment limit of $2,500 (five percent of the lesser number – $50,000) in contrast to the proposed rules in which that same investor would have been eligible for an investment limit of $10,500 (10 percent of $105,000). Less money to invest means less money for the small business that is crowdfunding.
What surprised me the most is that this limit applies to accredited investors also! Accredited investors can invest unlimited amounts in any other private offering of stock, but they are limited to invest a small percentage of their income or net worth in crowdfunded securities. I understand the SEC trying to prevent an elderly person on Social Security from possibly losing his life savings in a crowdfunding investment, but telling wealthy, sophisticated investors that they are limited in what they can invest makes absolutely no sense. And while we are on the topic, why is the government telling anyone how much they can invest, when these same potential investors have no government limits on how much they can gamble in a casino, how much fantasy football they can wager on, or how many lottery tickets they can buy.
How do you think the SEC did with their rulemaking?
The SEC was given a Herculean task to try to make sense of the mish-mash of laws that Congress put together and called the JOBS Act. Many provisions of the law are inconsistent, and creating a viable framework could not have been easy. As for Title III, when the proposed rules were released, I was very pessimistic that anyone would ever be able to use equity crowdfunding. But the final rules made a number of excellent compromises that will allow some companies to use the law to raise capital. Did the SEC go as far as I would have liked? Of course not, but who would expect them to? Would I have liked to see a $5 million limit instead of $1M, no limits on accredited investors, free flow of marketing information on social media and less paperwork and disclosures? Yes, but given what they were handed, I think the SEC did a good job making equity crowdfunding a reality for those who can afford to do it the right way. For others, we will have to wait until Congress revises the law someday, and truly makes it a law that democratizes the investment process for all.
Will the new rules work?
Equity crowdfunding could be the great equalizer for entrepreneurs and small businesses by allowing them to bypass the banks who will not lend to them, the venture capitalists who want to take advantage of them and wealthy Wall Street types who ignore them. But the law itself and the SEC rules just released will make the law unworkable for some small businesses because of the costs involved, and the restrictions on marketing imposed. Despite that, equity crowdfunding will work for some, and if the $1 million cap is raised someday, it will work for many more. In the meantime, there is always equity crowdfunding’s prettier sister out there, the Regulation A+ Mini-IPO.