In a Colorado Law Talks event, hosted by Akerman on Sept. 11, University of Colorado Law School Professor Andrew Schwartz presented his research on securities crowdfunding, a new way for startups to raise money.
As its name suggests, the idea behind securities crowdfunding bears some resemblance to sites like Kickstarter or GoFundMe. However, instead of seeking donations and rewarding contributors with, say, an autographed poster or premium podcast content, securities crowdfunding seeks investment from early stage investors who then get equity in the company.
Schwartz said the timing of the talk was auspicious because the Securities and Exchange Commission will be taking public comments until Sept. 24 about how to reform securities crowdfunding in the U.S.
Equity crowdfunding in the U.S. was first authorized under the Jumpstart Our Business Startups Act, or JOBS Act, signed into law by President Barack Obama in 2012. The SEC published rules four years later, and equity crowdfunding debuted nationally in the U.S. in 2016.
Before the national rollout, a number of jurisdictions introduced their own securities crowdfunding systems, including Colorado, which adopted the Colorado Crowdfunding Act signed into law by Gov. John Hickenlooper in April 2015.
According to Schwartz, promoting entrepreneurship was just one of the goals of authorizing equity crowdfunding. Another was to create more inclusive funding opportunities for entrepreneurs, who have traditionally been funded by friends, family or angel investors, Schwartz said.
Entrepreneurs without wealthy friends and family or connections to venture capital have historically missed out on investment.
Some hope the crowdfunding model can also address a gender gap in startup funding. Schwartz cited a statistic saying that women-led businesses receive just 15% of venture capital funding.
Schwartz and his research assistant analyzed filings from U.S. companies that raised money through crowdfunding campaigns from 2016 to 2018 and found that about 28% had at least one signatory with a typically female name. While he admits the methodology isn’t perfect — some names weren’t obviously gendered — it suggests crowdfunding may be helping to bridge the gap.
Equity crowdfunding also aims to expand investment opportunities to new groups, Schwartz said, explaining that angel investors in risky startups have typically been limited to personal friends of the founders or wealthy, universally accredited investors due to legal and registration costs that shut out smaller investors.
Schwartz presented a comparison of the legal framework for U.S. equity crowdfunding with that of New Zealand, where he conducted research on a Fulbright grant in 2017. The country introduced its securities crowdfunding system in 2014.
Both the U.S. and New Zealand cap the amount companies can raise at around $1 million (USD) per year, Schwartz said. But unlike the U.S., where investors can only invest a percentage of their income or net worth each year, and even the wealthiest investors max out at $107,000, New Zealanders can invest as much as they want. New Zealand also does not require any specific forms or disclosures to be filed, according to Schwartz, while the U.S. requires companies to file disclosures with the SEC, investors and the intermediary — typically a website — facilitating the investment. Schwartz said that, after adjusting for population and the size of the economy, New Zealand saw about 13 times more equity crowdfunding campaigns in its first year than the U.S. did in its first year and New Zealand companies raised 30 times as much money as those in the U.S. Despite the lack of regulation in New Zealand’s system, Schwartz said he doesn’t know of any cases of fraud related to the fundraising and has only heard of one bankruptcy since 2014.
New Zealand’s lack of a robust venture capital community explains some of the popularity of crowdfunding in the country, which has a lot of promising startups starving for investment. “They needed to develop a system that really worked” to get capital to young companies, Schwartz said.
Meanwhile, in the U.S., where more paperwork is required, startups are reluctant to pay lawyer’s fees to raise the relatively small amounts allowed through crowdfunding. According to Schwartz, several advisors for VCs have also said they wouldn’t invest in a company that had raised money through crowdfunding because they wouldn’t want to deal with potentially hundreds of existing stakeholders.
“If startups are very concerned [crowdfunding] is going to spoil their chances in the future, well, they’re not going to try,” Schwartz said.
The lack of regulation in New Zealand has also encouraged what Schwartz calls a “gatekeeper” effect, where crowdfunding websites have a stronger economic motive to vet companies to avoid damage to their reputations.
He said this has led platforms to be extremely selective, with the top one rejecting 98% of companies.
Another feature of the New Zealand system is what Schwartz calls “syndication,” in which one lead investor that has done due diligence makes an initial investment of hundreds of thousands of dollars, with smaller retail investors following suit. He said this is possible because of the lack of caps on individual investors, allowing the cornerstone investor to lead with a bigger dollar amount.
Schwartz encouraged the crowd to submit their ideas for reforming the U.S. system to the SEC and suggested a few of his own, including eliminating investor caps to encourage the syndication model seen in New Zealand and raising the limit that companies can raise per year. He said there are a lot of companies that need to raise $3 million or $5 million that struggle to attract investment from VCs and other more traditional sources.
— Jessica Folker