Capital Punishment

No, not that kind! We’re not talking about the death sentence for various crimes. This one is about money, pure and simple, and it’s about how a legal and economic system that has strangled (hmmmm?) small businesses with complexity and expense that currently requires very high costs to raise risk capital at time when banks simply will not lend to early stage entrepreneurs or small businesses. Credit is simply there for the big boys, including the mega-financial institutions that got us into this mess in the first place. For small business, these have been particularly harsh times.

How important is small business to the United States? The government’s Small Business Administration provides these facts on the FAQ (citing Bureau of Labor Statistics data) page: “Of 120.6 million non-farm private sector workers in 2007, small firms employed 59.9 million and large firms employed 60.7 million. About half of small firm employment is in second-stage companies (10-99 employees), and half is in firms that are 15 years or older. Small firms’ share of employment in rural areas is slightly higher than in urban areas; their share of part-time workers (22 percent) is similar to large firms’ share (19 percent). Small firms’ employment share remains steady since some small firms grow into large firms over time… Small firms accounted for 65 percent (or 9.8 million) of the 15 million net new jobs created between 1993 and 2009.”

After the 1929 “Black Tuesday” stock market crash, the federal government passed the Securities Act of 1933 and the Securities Exchange Act of 1934, basically reactions to the seeming fraud-laced capital markets of the 1920s, imposing standards on public and private offerings and requiring government clearance for access to the general public and trading in the secondary markets. State governments serially followed suit (since most offerings require compliance with federal laws and each state in which a solicitation is made), some with laws even more strict that those imposed by the feds. More statutes followed, and the federal Securities and Exchange Commission (and the state equivalents) promulgated a litany of policies, procedures and regulations on folks seeking passive investors.

Most of these laws focused on full disclosure and making sure the investors were actually able to afford the investment. But as the legal field got complex, this maze of regulation that applied to most levels of fund-raising created a hurdle that few on the small size could afford. Complex business plans with risk-driven projections prepared by expensive experts joined some of the most expensive legal talent in the country needed to create the necessary compliance documents, and where needed, to complete the registration procedures. Even the simplest transactions required tens of thousands of dollars of expertise, and significant raises started with six figure up-front costs and more often than not, hit the seven figure mark. For most small companies, until they could afford compliance, this often meant borrowing from family and friends, mortgaging the house (good luck in this market) or simply violating the law.

While the risks for smaller offerings may be low – but only because they often fall below the radar – the fact is that violating these securities laws can be a very serious felony (state and federal), may create debts that cannot be discharged even in a bankruptcy, and create so many civil liabilities that it would take pages and pages just to list the risks. Most folks don’t even know this and get angry when they are told how the law works, clearly giving the big companies and already-rich segment of our population (who can afford the compliance costs) access to capital that simply is not affordable for the rest. The playing field is anything but level.

That small firms account for so many jobs and so much job growth suggests that these barriers are no longer viable. Enter “crowdfunding.” While donations and sponsorships aren’t generally “securities,” much of the rest of this practice is currently on the wrong end of legal regulation. As Deborah Cohen writes for the March 2012 ABA Journal: “Websites such as Kickstarter and IndieGoGo—where filmmakers, food truck owners and more tell their stories in hopes of raising funds—have popularized the process. And President Barack Obama even endorsed crowdfunding in his September jobs speech last year… The largely Internet-based fundraising practice allows individuals, small businesses and others to raise capital from a variety of sources, including donations, sponsorships and the sale of products or services, with no expected financial return such as equity.

“As the funding form has grown in popularity, a diverse group of backers ranging from grassroots community activists to old-line conservatives has voiced support to allow crowdfunding to expand beyond current models. Securities and Exchange Commission and state regulations currently impose certain registration requirements on investors and the recipients of their financial largesse when securities are to be exchanged.

“But several bills now wending their way through Congress would eliminate some of those regulatory hurdles and open up investment from a broader range of backers… One of those bills, the Entrepreneur Access to Capital Act, HR 2930, eliminates an SEC registration requirement for small companies using crowdfunding to raise low levels of investment, a barrier proponents say inhibits many start-ups from getting out of the gate. Companies could raise up to $2 million annually from investors pledging no more than $10,000, or 10 percent of their annual income… The bill’s sponsor, Rep. Patrick McHenry, R-N.C., says the legislation ‘would modernize outdated securities regulations in order to free up capital for small businesses and entrepreneurs.’… A bill introduced by Republican Massachusetts Sen. Scott Brown would allow for even lower investment thresholds.”

Critics post concerns about the risks of fraudulent practices and exaggerated claims by entrepreneurs who just can’t help but extol the virtues of their offerings without believing in the risks. While indeed these are risks, at the levels contemplated in these bills, the balance of benefits to a nation desperate for job-creation against the highly limited losses any individual can face in the proposed levels of investment provide a clear path for both Republicans and Democrats to embrace this much-needed change. If anything, the proposals don’t go nearly far enough.

I’m Peter Dekom, and there are points in our legal system where overregulation actually does impair growth with little or no benefit to the country as a whole.