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For a little over a decade now, I've been crusading against the Accredited Investor Rule. It's not that it was a bad rule when it was instituted in 1934, and I'm sure it protected countless thousands of folks from being taken advantage of by hucksters over the years. But there's just no place for it in the Internet age. Today it serves only to isolate all but the very wealthy from private stock offerings - one of the most potentially lucrative sectors of the market.

The JOBS Bill, which passed the House by a landslide 407-18 vote, and the Democratizing Access to Capital Act (its sister legislation currently in the Senate) are set to change all of that by opening the private market (specifically start-ups) to crowdfunding.

Unfortunately, though the bill flew through the House, the Senate is dragging their feet a bit. Which is really ironic when you consider that each of them funds their reelection campaigns through crowdfunding and doesn't lose a moment's sleep over it. Be that as it may, if the bill eventually passes in its unadulterated form, here's what it will mean for investors, start-ups, and the economy on the whole:

Start-ups will be able to announce that they're raising money in the public forum of their choosing (Facebook, Twitter, the local paper, etc...) and they'll be able to raise up to $1 million each year. Something similar was tried in the late 90's under Regulation D (it was called SCOR - Small Company Offering Registration ). It never took off because the registration process was still really cumbersome and, once registered, the stock had to be sold through brokerage firms - most of whom wouldn't touch a deal for a $1 million or less.

The other problem with SCOR was that it was limited to accredited investors. So if you started the next Apple in your garage and your college buddies wanted to invest, they couldn't. The JOBS Bill solves both of these problems.

Assuming it passes, this is how it is most likely going to work:

Companies will announce that they're raising money. While they could theoretically raise it on their own, it is far more likely that they'll get listed on an intermediary crowdfunding site that works in much the same way Lending Club works for individual borrowers. Investors will be able to invest up to $1,000 per start-up, up to ten percent of their annual income. And there will be no accreditation required - anyone can invest.

This can be huge for the American economy. Innovative small businesses employ the vast majority of Americans, and with access to capital direct from individual investors these companies can put a lot more people to work. This is a big win for America.

But what about fraud? Don't poor, ignorant individual investors need protection from unscrupulous hucksters?

Here's how this is going to play out: Intermediaries (the future eBays of this space) will spring forward to handle the paperwork, do background checks on issuers (required), ensure that offerings are well described and enforce balanced investment terms. The House version allows start-ups to do this without an intermediary, but that's not going to happen in practice (it would be like trying to sell your item on the Web without eBay). And fraud? Crowdfunding is already legal in the U.K. The leader there, Crowdcube, is reporting zero fraud. U.S. crowd-lending site Prosper.com and accredited-investor-only U.S. crowdfunding site AngelList also report zero fraud.

This might be the smartest legislation to come out of DC in the past decade.

How big could it get? As it states in the article, if Americans just diverted one percent of their long term savings to this it would equal ten times the total amount of venture capital investments in the US.

If Bernanke wants to flood the economy with dollars, shouldn't we at least see to it they go to the right place? Start-ups are the future blue chips, and this legislation has been too long in coming.

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Comments (19)

  • In The Flesh's picture

    Won't the investment banks lobby very hard to make sure this doesn't pass? If startups and other companies are able to go directly to other funding sources via the web, won't that help drive down fees and weaken the current business model?

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  • APAE's picture

    ITF, I may be retarded for this, but I feel like "they'll be able to raise up to $1 million each year" kinda caps this at a scale where investment banks wouldn't be playing anyway.

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  • In reply to In The Flesh
    Edmundo Braverman's picture

    In The Flesh:
    Won't the investment banks lobby very hard to make sure this doesn't pass? If startups and other companies are able to go directly to other funding sources via the web, won't that help drive down fees and weaken the current business model?

    You can generally judge how good a given bill is by looking at those lined up against it. In this case, both Wall Street and the AFL-CIO are against it. Must be pretty goddammed good for the country.

    Besides, if you don't think that the web is the future of investment banking, you probably still get your stock quotes from the morning paper.

  • In reply to APAE
    Edmundo Braverman's picture

    A Posse Ad Esse:
    ITF, I may be retarded for this, but I feel like "they'll be able to raise up to $1 million each year" kinda caps this at a scale where investment banks wouldn't be playing anyway.

    This. It was the same problem with SCOR - good in theory but the deals weren't large enough to even interest the boiler rooms, much less a BB. And SCOR allowed companies to raise up to $1.5 million, if memory serves.

  • panther2k's picture

    This is actually incredibly interesting to me. I've been working on a startup on the side over the past couple.months and plan to become a FT entrepreneur once my analyst stint ends this summer. obviously I'd need to do a bit of work on this to make sure that it isn't something a kiva or kickstarter could just roll out before we even got started, but if any fellow monkeys have an interest in possibly joining forces shoot me a pm and we'll talk.

  • Anomanderis's picture

    I'm ambivalent of this bill. It's all about stripping protections and regulations. We've been here before, it didn't end well. This whole idea of crowdsourcing, while removing penalties for mis-information makes no sense to me. Investors will simply panic on the possibility that company owners aren't expected to provide accurate information

    It appears to be a huge invitation for scammers to commit fraud. Stripping investor protections?

    I really, really don't get this.

    PS - Remember that the UK has far stronger regulations than the US.

    But Rhaegar fought valiantly, Rhaegar fought nobly, Rhaegar fought bravely.

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  • Relinquis's picture

    This is interesting. There's a letter from the CFA Institute that highlights their concerns with this form of the Act.

    In particular, we are concerned that the proposal to permit brokerage
    firm analysts write and distribute research on companies whose IPO shares their firms are underwriting
    will lead to the kind of conflicted research that
    decimated investor confidence in the late 1990s and early 2000s

    They go on to suggest changes to the Act:

    These include:
    - Annual audits of companies included in an annual report to shareowners.
    - At least semi-annual updates on performance and financial condition.
    - Public disclosure of all important company news through normal channels.
    - Company principals liable for fraudulent representations.
    - Separate exchanges for companies benefiting from the Act's exemptions.
    - Shares sold through crowdfunding to remain unregistered.

    What do you guys think?
  • In reply to Anomanderis
    RagnarDanneskjold's picture

    Anomanderis:
    I'm ambivalent of this bill. It's all about stripping protections and regulations. We've been here before, it didn't end well. This whole idea of crowdsourcing, while removing penalties for mis-information makes no sense to me. Investors will simply panic on the possibility that company owners aren't expected to provide accurate information

    It appears to be a huge invitation for scammers to commit fraud. Stripping investor protections?

    I really, really don't get this.

    PS - Remember that the UK has far stronger regulations than the US.

    MF Global, Worldcom, Enron....This is a great piece of legislation (never thought I'd say that).

  • In reply to RagnarDanneskjold
    Edmundo Braverman's picture

    RagnarDanneskjold:
    Anomanderis:
    I'm ambivalent of this bill. It's all about stripping protections and regulations. We've been here before, it didn't end well. This whole idea of crowdsourcing, while removing penalties for mis-information makes no sense to me. Investors will simply panic on the possibility that company owners aren't expected to provide accurate information

    It appears to be a huge invitation for scammers to commit fraud. Stripping investor protections?

    I really, really don't get this.

    PS - Remember that the UK has far stronger regulations than the US.

    MF Global, Worldcom, Enron....This is a great piece of legislation (never thought I'd say that).

    Exactly. What has the SEC ever accomplished? They had Madoff handed to them with a bow on him in 2001 and fucked it up. The only thing the SEC serves to do is create a monopolistic environment for the BBs and prosecute meaningless three-inch putt insider trading cases.

    @Relinquis I actually agree with all of those proposals, with the exception of requiring audited annual reports. Annual reports should be required, but auditing is too expensive and time consuming for a typical start-up.

    As far as the "Henry Blodget Clause" (sorry Henry!), the existing regulations should prevent that kind of abuse. Or, rather, if they don't prevent that kind of abuse, they're not protecting investors from it on IBM either.

  • ConanDBull's picture

    $$
    O

    i've been thinking about this for a while since my startup died out back in 2011 lol... its still illegal in Canada though... the Candian Advanced Technology Alliance has been pushing to try and get something similar as well
    http://www.cata.ca/Media_and_Events/Press_Releases...

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  • IlliniProgrammer's picture

    Bear in mind that a lot of IPOs are for less than $1 Billion, which is one of the provisions in one of the bills.

    My problem with the IPO process is that the bankers and the issuers have too much say over the accounting.

    Honestly, there needs to be an option where you hand your books over to the SEC, let THEM figure out your firm's accounting, and produce your prospectus for you.

  • In reply to IlliniProgrammer
    Edmundo Braverman's picture

    IlliniProgrammer:
    Honestly, there needs to be an option where you hand your books over to the SEC, let THEM figure out your firm's accounting, and produce your prospectus for you.

    I just threw up in my mouth a little.

    I get what you're saying, IP, and I agree. I'd just sooner have the Orkin man handle my firm's accounting than the SEC.

    But that's a good idea: use an independent third-party accounting firm to provide uniform financial data and prospectuses (prospecti?). Also, there is no reason in this day and age that 10-K and 10-Q financial data should not be provided in Excel format.

  • IlliniProgrammer's picture

    I get what you're saying, IP, and I agree. I'd just sooner have the Orkin man handle my firm's accounting than the SEC.
    But that's a good idea: use an independent third-party accounting firm to provide uniform financial data and prospectuses (prospecti?). Also, there is no reason in this day and age that 10-k and 10-q financial data should not be provided in Excel format.

    That's my view. There needs to be a process for IPOs where we have a standardized accounting system. Take the marketing out of the game and you get money going where it needs to go in the economy.

    Of course, it will put some bankers, brokers, and salespeople out of work. But they're not really creating much social or economic value in the first place.

    This is the company. This is what it does. This is what its finances look like. Take it or leave it.

    I'm happy making it a regulated monopoly or a government agency. I also want the employees (actually, all federal and state regulators, officials, and politicians, too) to sign a document stating that their federal tax rates are 70% on all income over $1,000,000 for five years after they leave. Take away the incentives to collude, and you get less collusion.

    I also think that there needs to be a sort of bankruptcy process with an IPO. An issuer needs to list all of its liabilities and contingent liabilities. If a creditor is not on the list when the firm IPOs, the officers might be liable, but the corporation isn't.

    Also Eddie, 10ks/qs are available in XML format these days. Not exactly Excel/CSV, but close enough for any programmer.

  • accountingbyday's picture

    Relinquis, I actually agree with those suggestions. I was actually going to ask if audits or quarterly reporting of any kind were required in this bill.

    Eddie - audits aren't always that expensive and may not be necessary. There are actually different type of attestation services a CPA can provide. Less thorough (and less costly) than an audit is a review. A review might be good enough for some people in this scenario. That being said, if they're raising $1M an audit should be peanuts for them. An audit of a small startup can happen in under a day. Plus, if these companies wanted any other type of funding they'd probably be required to get an audit anyways.

    Overall, I think this is a VERY positive step. Personally, I'd love to invest $1k in some younger stage companies that I believed in. That being said, it's not perfect.

    While I understand the rationale for limiting the amount of investment, I think $1k is too low. I'm still a young guy and $1k is a fairly insignificant investment even to me. There are other people who feel the same way about $10k or even $1M. My gut tells me a $50k limit is the right amount.

    Also, limiting this to 10% of annual income is stupid. Again, I get the point, but I don't need the government to protect me. Obviously, % of Net Worth would be more appropriate (but not ideal because it's not as easy). If I retire at 40 with $10M in the bank conservatively invested earning 3% I can only invest $30k per year? That's dumb too.

  • Ari_Gold's picture

    Interesting. Hey a question this swirls in my head is, what will this do to the Venture Cap industry? As an entrepreneur why would I seek out VC firms and give them a pound of flesh for seed money. I understand that VC firms also offer a lot of value added in terms of advice, guidance, coaching, and networking.

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  • In reply to Ari_Gold
    Edmundo Braverman's picture

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  • imallcash's picture

    It's all manipulated with junk bonds. You can't win.