If starting or growing a business weren’t hard enough before the financial crisis, try doing so today.

BACKGROUND:

• According to the Small Business and Entrepreneurship Council, Small businesses represent over 99% of the employer firms in the U.S., and employ half of the private sector employees.  Between 1993 and 2009, small businesses accounted for 65 percent of the 15 million net new jobs created.  Bureau of Statistics data shows that since the 1970s small businesses hire two out of every three job seekers and the Ewing Kauffman Foundation has noted that in the last 30 years, all net job creation in the U.S. took place in firms less than five years old.

• According to the Department of Labor, prior to the financial meltdown, 76% of small businesses received traditional funding (ie: bank loans, credit card advances, finance companies, etc).  Any entrepreneur will tell you that cash is king.  Without it you cannot grow or hire employees.  Part of this comes from working capital (cash on hand) and the other part from financing (traditional funding just mentioned).  With the financial meltdown, our economy stalled, over 8 millions jobs were lost and unemployment rose to its highest level in recent history.

• Economists and politicians are in agreement.  Jobs create prosperity.  With the launch of Startup America in February 2011, the White House stated that, “Startups bring a wealth of transformative innovations to market, and they also play a critical role in job creation in the United States.  Those entrepreneurs who are intent on growing their businesses create the lion’s share of these new jobs.”  Jobs create taxable wages and spending which stimulate the economy and replenish the government coffeurs.

CURRENT ENVIRONMENT:

• Since the financial meltdown traditional financing has virtually disappeared.  Banks are holding on to their cash, credit card companies are charging exorbitant interest rates and according to the private financing group Angelsoft, only 2.3% of startups receive private (VC, PE or Angel) financing.

• Since money isn’t available to the other 97.7% of startups today, they need to find other avenues to raise capital; namely their friends, family and community.  However, if that startup offers any kind of financial return, it just might be breaking the law.  That is, unless they hire a lawyer, spend tens of thousands of dollars and countless hours completing forms.

• According to the Sustainable Economies of Law Center[1], “the current registration requirements under Section 5 of the Securities Act of 1933, as well as existing exemptions from registration, impose considerable hurdles on small businesses.” The securities laws were written to address the abuses of large corporations.  However today, these laws, written before telephones were widely available, require a small start-up raising $50,000, to follow the same filing requirements as a large corporation seeking to raise millions of dollars.

• Even if a startup were to complete these filings, the current regulations also include:

1. Limits on startups in seeking capital outside of their immediate state
2. Requirements of additional costly and burdensome state filings
3. Restrictions on the amount of “unsophisticated” investors to 35 individuals and/or
4. Requirements for complete audited financials and state filings

• In 1933 when these laws were written, 4% of Americans invested in the markets.  Today that number is over 50%, clearly showing that the majority of individuals understand the basics of investing.

NEW IDEAS FOR FUNDING BUSINESSES:

• Crowd fund investing, where groups of people invest in startups and provide the capital where it otherwise isn’t available, is one such solution.  Over the past 5 years, users of websites like Kiva & Kickstarter have “donated” over $300M to crowd fund projects including art, films, software development and books.  “The success of these crowd funding sites demonstrates the desire of the public to support projects that they believe in. Enabling the additional motivation of possible financial return would only reinforce this economically healthy impulse,” says the Sustainable Economies of Law Center.

THE SOLUTION:

• Update the 78-year-old Security and Exchange Commission’s (SEC) rules that impact how entrepreneurs can raise capital. These rules require filings that are beyond the capabilities of entrepreneurs or small businesses.  They require tens of thousands of dollars of legal and accounting professionals time…money that small businesses do not have.  (Please Note: This is not a new idea.  Proposals to update these rules have been recommended to Congress every year, for the past 18 years).

• We support creating common sense modifications to existing regulations to enable small businesses to raise capital through debt or equity.  The reforms are modest and follow the spirit of the 1933 and ‘34 Security Acts including:

1. Strong anti-fraud provisions
2. Limited risk and exposure for unaccredited investors
3. Transparency
4. Standards-based reporting
5. Limit to the amount of seed capital a company can raise in this type of offering.

a)   We propose the creation of a “funding window” for the creation of debt or equity instruments for entrepreneurs and small businesses.

“Small Business” will be defined as one with average annual gross revenue of less than $5M during the last three years or since incorporation if the business has existed for less than three years.

This “funding window” could be accessed by small businesses in one or more tranches, to raise up to $1M over the life of the business.  Two examples follow:

1. Small Business A is an entrepreneur with an idea for a business.  He raises money in the following tranches:

• Round A:  $5,000 to do market research & create the business plan
• Round B:  $50,000 to build a prototype
• Round C:  $200,000 to expand operations
• This company now chooses to use traditional means of financing for subsequent rounds.

2. Small Business B is a dry cleaner that needs additional working capital to open a second location and cannot get traditional financing:

• Round A:  $250,000 for construction
• Round B:  $100,000 for working capital and equipment
• Round C:  5 years later, they prepare to open a 3rd branch and raise an additional $650,000.
• With the completion of Round C, this “funding window” is now closed to this business.

Crowd Fund Investing is based on the experience of “Crowd Funding” sites for charitable and art-related projects.  It provides a way for unaccredited investors to pool their individual small contributions (likely between $50 – $500 each), in companies and entrepreneurs they believe in.  In order to limit investor risk, we support the creation of caps on the amount each individual can invest in an entrepreneur or small business.

b)  We support limiting the contribution of an individual “unaccredited investor” to no more than $10,000.  The $10,000 limit is in line with other established financial disclosure limits like those on banking transfer reporting requirements.

c)  Require a set of standardized and automated procedures for these financing offerings to reduce time and expense for all parties while maintaining transparency.

d)  Investors will have to complete a questionnaire to determine their aptitude to participate in Crowd Fund Investing and answer a series of disclosures that demonstrate they have prior experience with making investments and/or are familiar with the principles of investing and associated risks.

e) Eliminate the 500-investor limit and the broker/dealer license requirements for Crowd Fund Investing via this window.

f) Exempt these offerings from state law registration requirements based on the limited size of the amount that can be raised, but leave intact applicable state law notice filing requirements, similar to the way SEC Rule 506 currently works.

g) Allow for general solicitation on registered platforms where individuals, companies and investors can meet virtually, ideas can be vetted by the community as sort of peer review, informed decision can be made on whether or not to invest their money and crowd fund investing can take place.  These platforms would provide standards-based reporting to the SEC on the entrepreneurs and small businesses utilizing the platform.

The SEC has the authority to make these changes today:

• According to Section 3(b) of the Securities Act, the SEC grants the commission the power to:

Add any class of securities to the securities exempted as provided in this section, if it finds that the enforcement of this title with respect to such securities is not necessary in the public interest and for the protection of investors by reason of the small amount involved or the limited character of the public offering …

It is time our Government eased the restrictions on capital formation for startups/small businesses in order to create the jobs our country needs to rebuild itself.