Small California Businesses May Get OK for Equity Crowdfunding
American Grilled Cheese Kitchen is a San Francisco success story with 33 employees, two bustling restaurants, in the Mission District and South Park, and plans for a third in North Beach. Co-founder Nate Pollak has even bigger dreams: He’d like to open outlets throughout the Bay Area and nationally.
He needs money to do so. A decidedly non-tech enterprise like a restaurant won’t lure deep-pocketed venture capitalists seeking skyrocketing growth and a gargantuan payday. Bank loans aren’t big enough. Instead, he’d like to raise $1.5 million in two years from lots of mom-and-pop investors, offering them a slice of the business in exchange for small-scale investments — an approach called equity crowdfunding.
But laws limit his ability to ask for that kind of money.
“Here I am, 31 years old, full of energy, I operate two profitable business with really great numbers; we’ve proven ourselves in one of the toughest restaurant markets — and I can’t get a dime,” Pollak said.
That could soon change.
Two bills pending in the Legislature would allow small companies to do equity crowdfunding within California, reaching out to both “accredited investors” (higher-net-worth individuals presumed to have financial savvy) and “nonaccredited investors” (the general population). And last week, the Securities and Exchange Commission adopted new rules for medium-size companies nationwide to streamline selling securities. As a securities offering, equity crowdfunding is more heavily regulated than crowdfunding for creative projects through sites like Kickstarter and Indiegogo — essentially donations in exchange for rewards like receiving products or attending events.
“These (proposed California) bills are trying to democratize opportunities for more investors who might have a passion for a particular industry and would like to invest,” said Eileen Loustau, senior vice president of Pensco, a San Francisco firm that helps people invest their retirement accounts outside the stock market — including in equity crowdfunding. It recently released a report on the topic.
Of course, equity crowdfunding opens a door for scam artists — one reason it’s so heavily regulated. But proponents of the California bills say they have thought through safeguards.
“Any funding proposal under our bill would have to be reviewed by the California Department of Consumer Oversight,” said Scott Hauge, president of Small Business California, a trade group backing one of the California bills, AB722 from Assemblyman Henry Perea, D-Fresno. “We think that will address protections for consumers.”
A similar bill last year didn’t make it through the Legislature. AARP was particularly vocal in raising concerns about opportunity for fraud against seniors.
Likewise, Christina Oatfield, policy director of the Sustainable Economies Law Center in Berkeley, which backs another proposed bill, SB577, and drafted its language, said it is narrowly focused purposefully to thwart con artists.
“Access to capital is a big deal for small businesses,” Hauge said. “We want to open the window for them to reach out (for funding). We think this would be really beneficial for them.”
Being able to advertise is a big component of both bills.
Right now, “I cannot announce on the restaurant Facebook page that I’m raising money,” Pollak said. “I cannot write an e-mail to my customers; I cannot publicly say anything about it. Technically I’m only allowed to contact accredited investors within my personal or professional network.”
AB722 would let businesses raise up to $1 million a year with each investor chipping in up to $5,000 or 10 percent of the investor’s net worth, whichever is less. Companies would be able to solicit California investors via e-mails; announcements on their websites; advertising online; in newspapers and TV; and other methods.
Companies would not be confined to using third-party portals that charge up to 15 percent of the amount being raised. Instead, they’d pay a fee of 0.4 percent of their issuance, which would allow the Department of Consumer Oversight to hire additional attorneys to vet proposed issuances.
SB577, the Local Economies Securities Act from state Sen. Ben Hueso, D-San Diego, would ease equity crowdfunding for agricultural and renewable-energy enterprises, as well as for small companies seeking lower amounts of money.
The two bills, both introduced in February, are not mutually exclusive.
SB577 would let small farms, agricultural land trusts and nonprofit or cooperative renewable-energy companies raise up to $2 million a year in increments of $5,000 per investor (or up to $1,000 for investors who make less than $50,000 a year). It, too, would allow the companies to advertise their fundraising to California investors.
“You could send an e-mail blast to your customers and fans; you could tell friends and family; you could go to community group meetings and stand up and say, 'Hey, this is my business, and I’m offering to sell stock or seeking loans,’” Oatfield said.
SB577 also creates frameworks for smaller-scale enterprises to do equity funding, allowing the companies to raise up to $100 per investor for a total offering of up to $100,000, or up to $1,000 per investor for a total offering of up to $500,000. Another provision would allow member-owned consumer co-ops to raise up to $1,000 per member, up from the current state limit of $300.
The federal Jobs Act, passed in 2012, was supposed to liberalize equity crowdfunding. But it set up lots of hurdles. The Securities and Exchange Commission is supposed to clarify rules for equity crowdfunding under the Jobs Act, but has been slow to do so.
California would join more than a dozen states that have done end-runs around the Jobs Act to implement their own equity crowdfunding rules. All those rules have a crucial limitation: Companies can raise money only within their state.
“States are taking their own initiative because they don’t see things moving fast enough at the SEC,” said Loustau.
No major problems
The biggest concern for those states is making sure companies don’t accidentally advertise outside the state, which would violate SEC rules. Supporters note that the states allowing equity crowdfunding have not seen any major problems or scams crop up.
Crowdfunding advocates hope that all the state bills will get the SEC to act. “Every state that does this, it creates positive momentum and influence on what we all want, which is federal rules,” said Judd Hollas, CEO of crowdfunding siteEquitynet.com, based in Arkansas.
Like other online equity-crowdfunding companies, Equitynet reaches out to accredited investors nationwide and so abides by the federal rules rather than trying to comply with a patchwork of different state regulations.
Pollak is waiting eagerly to see whether the Legislature creates a way for California companies like his to seek money from the crowd.
“I’ve grilled a lot of cheese,” Pollak said. “I’d love to be able to raise more capital to grow the business.”
Carolyn Said is a San Francisco Chronicle staff writer. E-mail: firstname.lastname@example.org Twitter: @csaid
Equity crowdfunding: Selling an ownership stake in a company to multiple people, also called peer-to-peer investing. This activity is regulated by the Securities and Exchange Commission and often limited to accredited investors. Two pending California bills would allow California companies to do equity crowdfunding with nonaccredited investors, meaning the general public — as long as the investors live in California.
Online crowdfunding: Kickstarter, Indiegogo and similar websites let people give money to creative endeavors in exchange for a small reward, such as a product under development or access to special events.
Peer-to-peer lending s ites such as LendingClub and Prosper let borrowers seek unrelated investors to make unsecured personal loans with preset interest rates and payback plans.
Accredited investor: A person whose net worth is more than $1 million, not including a primary residence, or whose annual income is at least $200,000 ($300,000 for couples). The United States has an estimated 9 million accredited investors. SEC rules now limit many types of investments, such as equity crowdfunding, to accredited investors, on the assumption that they are financially savvy.
Nonaccredited investors: Anyone in the general adult population who wants to invest.
Sources: Chronicle research, Pensco, Sustainable Economies Law Center
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