Securities experts in Wisconsin, a state badly in need of more early stage capital, are unenthusiastic. Several gave the legislation a passing or incomplete grade last week at a meeting of the Wisconsin Technology Council and BizStarts Milwaukee.
The boldest departure in the law enabled “crowd funding,” and that is the section that drew the coolest response. It allows on-line solicitation of up to $1 million annually from small investors, which sounds wonderfully democratic. Throw your great concept for a business out there on the web, and the crowd of small investors will come running.
But securities laws were put into place for a reason, to prevent investors from getting ripped off, especially the small investors. The law attempts to protect those unaccredited investors by installing caps of 5% to 10% of income in a scale up to $100,000.
It’s the pragmatics surrounding money raising, though, that offers the greatest limitation to this fund raising innovation.
“If you are a widget manufacturer, this is probably not the way to go, because of the transaction costs,” said Sandie Pendleton, a Milwaukee business attorney. He said entrepreneurs have to look at every shareholder as a potential plaintiff, which means lots of record keeping, controls and communication. And, if there ever is a suit, courts and juries tend to favor the little guy over the company.
In short, small shareholders may be more trouble than they are worth. They take more care and feeding than sophisticated accredited investors, those with a net worth of $1 million or income of $200,000.
Joe Hildebrandt, the godfather of early stage investing laws and fund managing in Wisconsin, said the biggest problem for a young company comes when it needs a second round of funding to fuel its growth. No angel or venture fund would want to deal with a couple hundred first round investors.
Hildebrandt runs two angel funds in Dane County. “We would just pass on it, with all the baggage involved,” he said. Pendleton allowed that on-line fund raising might work for some small businesses, like a micro-brewery, that aren’t planning a second round. Or, he said, crowd funding might be used for organizations that are looking for a broad base of support, like the Green Bay Packers or the Mustard Museum.
One web site, Kickstarter, which started in 2009, has raised funds for startups, but only ones that don’t yield a return. It funds creative products like movies or music. It’s more like a donation than an investment. Some non-monetary benefits might follow, like preferred seating in a theater or restaurant.
The law also requires that the crowd funding be run through an “intermediary,” which won’t be defined until the regulations are drafted by Jan. 31. That new entities will have to do some due diligence on the deals being floated.
Another section of the new law loosens the rules on general solicitation of accredited investors. At present, no advertising can be used during fund raising. That restriction goes away, but the definitions of what constitutes an accredited investor could be tightened when the new rules are written. Now, a self-declaration is pretty much the standard.
The Securities and Exchange Commission has missed its July 4 deadline for spelling out the rules on whether those supposedly sophisticated investors will have to take additional steps, such as providing tax returns or financial statements before investing. If so, the rules relaxation could be a wash.
Pat Struck, securities administrator for Wisconsin, said she did not see a huge impact from this change. She is waiting for the rules to come down and expects most of the regulation to be done at the state level.
Overall, Hildebrandt gave the act a positive rating. “At least, they are trying to do something” about job creation, he said. Pendleton had a similar assessment, because the new law is a step toward “an ownership society.”
There continues to be a big head of steam in Wisconsin and other Heartland states toward creating innovation-based economies led by entrepreneurs. But a growing number of accredited angel investors, who understand risks and startups, will have more to do with driving that strategy than will the crowds.