This month, the Assembly Committee on Banking and Finance will hear AB 722 (Perea), a bill I drafted for Small Business California that will legalize equity crowdfunding in California.
AB 722 allows entrepreneurs to raise capital by selling equity stakes in their companies to the public. The process will feel similar to the crowdfunding going on now that you may have heard about where companies raise capital through large numbers of small donations on Internet sites like Kickstarter and Indiegogo in exchange for T-shirts, first-dibs on products, and movie production credits.
But AB 722 crowdfunding will be different because investors will own a piece of the company, which automatically introduces securities law into the equation.
Crowdfunding of equity will enable entrepreneurs to use modern communication technology to solicit directly large numbers of prospective investors on social networks and, more broadly, on the Internet, thereby “democratizing” access to capital. For most on Main Street, it will be their first opportunity to invest in and potentially realize returns from an asset-class historically accessible only by professional venture capital investors.
Yes, without the promotional efforts of intermediaries such as Wall Street investment bankers and underwriters, entrepreneurs may only be able to raise a few hundred thousand dollars. But today, with technological advances in computer programming, a few hundred thousand dollars is sufficient to prove-out concepts, produce prototypes and get the attention of Angel-investors and other capital sources that are capable of making much larger investments.
Equity crowdfunding was supposed to be legalized at the federal level with enactment in 2012 of the Jumpstart Our Business Startups (JOBS) Act. Prior to the JOBS Act, Depression-era laws restricted a businesses’ ability to solicit the public to raise capital without registering the offering with the then-newly created federal agency, the Securities and Exchange Commission. For 90 years, without registration, companies could only solicit investment from people with whom they had pre-existing relationships.
The JOBS Act was meant to change those rules. Unfortunately, balancing capital access with investor protection is not easy. The SEC has yet to issue final rules for crowdfunding under the JOBS Act (its present rules limit crowdfunding to high net worth (over $1 million) investors). In response to this delay, and in an effort to stimulate job creation, 18 states have rushed to enact their own intrastate crowdfunding laws. While well-intentioned, these laws do not adequately protect investors. With the exception of Maine, these states allow companies to raise capital directly from large numbers of unsophisticated investors without any review by the state securities regulators or by the SEC.
Given the relatively small sums of capital at stake in a crowdfunded offering, most entrepreneurs will treat equity crowdfunding as they do non-equity crowdfunding…they will not likely seek legal counsel or other professional advice about the detailed and transparent disclosures that are required to be made to investors in securities offerings.
Assemblymember Perea’s AB 722 contains several important investor protections, such as prohibiting unsolicited telephone calls to potential investors. But perhaps most importantly, AB 722 offers entrepreneurs the benefit of a review of their offering by state Department of Business Oversight attorneys who are experienced in securities law disclosures and the securities raising process.
This is an area where DBO involvement in the regulatory regime makes good sense. We are confident AB 722 represents a smart approach to capital access that will benefit entrepreneurs, the investing public and California’s economy.