Crowdfunding Bill Moving Swiftly Through Arizona Legislature
When people hear the word "crowdfunding," websites such as Kickstarter or IndieGoGo usually come to mind.
Those sites provide a platform for people to donate money to charitable events, help a music band launch a new album and help local businesses get off the ground.
But if a private company wants to raise money through shareholders, similar to selling shares a public stock exchange, the general public can’t participate by federal and state law. That’s reserved for only “accredited investors,” or wealthy, financially savvy individuals.
But that could soon change in Arizona.
House Bill 2591 would allow "equity crowdfunding," meaning any Arizona resident with any income could buy stock in a locally based private company.
The idea behind equity crowdfunding is to create a new avenue for small businesses and start-ups to gain access to capital they otherwise couldn’t obtain through traditional routes, such as a bank, angel investor or venture capitalist.
“They’re struggling to find those earlier and smaller amounts of funding,” said Sidnee Peck, director of the Center for Entrepreneurship at Arizona State University’s W.P. Carey School of Business. “So they’re not quite ready for an angel group, they’re definitely not ready for venture capital and they don’t have what a bank typically requires in order to get a loan. So they might be stuck needing $10,000, $20,000, $50,000 and they just can’t obtain it.”
During a Senate Financial Institutions Committee hearing last week, Senator David Farnsworth said he thinks it’s one of the most important bills this session.
“I have yet to find someone who is not in favor of this most important piece of legislation,” Farnsworth said.
The basis for the bill stems from the Jumpstart Our Business Start-Ups Act, also known as the JOBS Act, signed by President Barack Obama in 2012. A portion of the JOBS Act required the Securities and Exchange Commission, which regulates the nation’s securities industry, to create new rules to allow equity crowdfunding nationwide.
Those rules were supposed to be in place by December 2012, but the SEC still hasn’t acted.
Thus, some states began taking matters into their own hands.
About 15 states have passed their own equity crowdfunding laws so far and Arizona is among several currently considering doing the same.
These state laws allow crowdfunding only if the business and investors are located within that state. Crowdfunding can’t happen across state lines until the new SEC rules are in place.
“But I’m certain if the federal government gets its act together a lot of these state laws will kind of just go by as interesting political pressure on the federal government to get its act together,” said Jonathan Frutkin, attorney and founder of Phoenix-based Frutkin Law Firm.
He also recently wrote a book about equity crowdfunding and founded Cricca Funding following the JOBS Act to help private companies with handling securities offerings and working with shareholders on the back-end.
Frutkin said these state laws are a step in the right direction, but it’s not helping the equity crowdfunding take off in a big way because business are limited to investors within state boundaries.
“I think the Arizona law is a great step forward that shows that we really want to find ways for Arizona businesses to be part of this growing trend of creating capital from our community and our customers,” he said. “On the other hand, I also recognize that the experience thus far has been as mostly a symbolic activity having an intrastate crowdfunding law. Most states that have it, it has resulted in very little additional financing activity.”
One of the biggest concerns raised by equity crowdfunding is that it puts unsophisticated, inexperienced investors in risky situations with businesses that often fail in their early stages.
“Understand that they most likely will never see their money again,” she said. “That’s the attitude you have to go into it with. This is not a plan for retirement savings or a way to make money quickly within the next couple of years.”
To help safeguard members of the general public, HB 2591 would cap the amount of money each individual invests in a company at $10,000, unless they’re an accredited investor. The bill would also place a $1 million to $2.5 million cap on how much money a company can raise within a 12-month period, depending on whether the company has undergone a financial audit.
Peck said the payoff could also be huge for the local economy.
“This could potentially create a significant number of jobs if it means that businesses that never would have started or made it very far, do,” she said.
However, equity crowdfunding isn’t for everyone. It takes a lot of time and effort to have shareholders that could otherwise be spent growing the business itself, Frutkin said.
“The disadvantage for a business is that you are basically turning yourself onto a lot of the time that you spend with investors generally,” Frutkin said. “And you multiply that out, instead of having five investors you have 50 or 500, you’re going to have to deal with all these people. That includes explaining what’s going on with the business, providing financial information, but also providing basic things like tax forms and dividend checks.”
But for local business owners such as Jon Stoddard, who owns Tucson-based Century Hearing Aids, the opportunity for growth is worth it.
“I would rather sell shares and own 40 percent of a company doing $50 million than 100 percent of a company doing less than $1 million,” Stoddard said during a House Banking and Financial Services Committee hearing last month.