Stalled Crowdfunding Rules Leave Business Plans on Ice

By ANGUS LOTEN

Scott Schroeder needs financing for his small electronics assembly business to hire more workers amid a recent surge in demand for its services. His bank recently refused to increase the Oregon company's credit line, forcing him to consider selling equity in his company to dozens, and possibly hundreds, of investors online.

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Leah Nash for The Wall Street Journal

Scott Schroeder aims to sell online stakes in his Mega Tech of Oregon.

Online solicitation of unsophisticated investors currently is barred under federal securities law. But Congress in April passed a new law that would allow "equity crowdfunding," allowing entrepreneurs like Mr. Schroeder to more easily get money for their businesses.

Under the so-called JOBS Act, Mr. Schroeder and other small and medium-size businesses would be able to raise as much as $1 million each year by selling shares in their business online, without the costly and burdensome process of registering with the U.S. Securities and Exchange Commission.

Mr. Schroeder says his Corvallis-based Mega Tech of Orgeon intends to be a pioneer. He hopes to raise at least $500,000 for his 35-employee plant through online connections with potential investors on the Web. "I'm looking for money to grow, but banks aren't willing to take any risks," he says, adding that he will "gladly give out equity" to get capital.

He would like to add as many as 15 assembly workers to meet the demands of high-tech startups including medical device and touch-screen payment product makers cropping up in nearby Portland, Ore. "We have underutilized equipment and want to fill that capacity," he says. Mega Tech did about $6 million in sales in the last 12 months.

What's holding him back? Right now, it is unclear what will be possible under the law and what kind of information he would be required to provide investors under the still-to-be drafted rules.

There also are questions about how crowdfunding investors can be made fully aware of the risks and what role traditional oversight agencies such as the Financial Industry Regulatory Authority, or Finra, might take in policing online equity sales.

The SEC is still hammering out its rules. The commission was given until January 2013 to set the rules, but is widely expected to miss that deadline. Agency Chairman Mary Schapiro will step down Friday, a move that is likely to delay the rule-making progress. An SEC spokesman declined to comment.

Finra, an independent regulator for all U.S. exchange markets and brokers, also was required under the JOBS Act to set its own equity crowdfunding rules. But unlike the SEC, it wasn't given a deadline. In July, it sought public comment on a host of crowdfunding rules, including advertising, fraud and manipulation, and trading principles.

Another business awaiting regulators' decisions is Pizza Lounge, a fledgling restaurant chain, whose co-owner Gil Aouizerat wants to raise up to $250,000 in equity sales through a crowdfunding site to open a fourth location, in San Clemente, Calif.

The chain has two outlets in California, both of which opened within the past two years, and a third scheduled to open in Las Vegas in February. Each outlet employs about six full-time workers and a 20 part-timers. Mr. Aouizerat would like to sell a 25% stake in the planned San Clemente outlet. And while he's at it, he says, if the equity-crowdfunding strategy works, he can move ahead with a plan to open five more locations by the end of next year.

He also was denied a bank loan for the expansion because his bank wasn't convinced his expansion would succeed. Mr. Aouizerat believes raising funds on an equity crowdfunding website would "turbocharge our growth." He says he is frustrated by the slow pace of the rule-making process.

In a November survey of 740 small-business owners, with between $1 million and $20 million in annual revenue, only 21% said they were aware of the JOBS Act. Just 3% of small businesses said they felt they would benefit from equity crowdfunding, according to the survey, by The Wall Street Journal and Vistage International Inc., an executive advisory group. The downside of the strategy for business owners is likely to be the potential hassle of managing many investors, each with a small stake in the company.

Last month, there were 8,800 Web domain names registered in the U.S. and Canada using some form of the term "crowdfunding," up from 900 in January. Existing crowdfunding websites such as IndieGoGo or Kickstarter currently serve to raise funds for projects such as films, art shows and business startups. But the contributors aren't investors and don't receive equity stakes in the projects. To comply with current U.S. securities laws, the fundraisers can only provide their contributors with mugs, T-shirts and other gifts.

Under the new law, businesses that wish to sell equity stakes online to investors must use only registered websites—though the sites don't necessarily have to be registered as broker-dealers. And the investors they attract can be just about anybody, rather than being limited to the high net-worth individuals who are typically deemed by regulators to be "accredited" investors.

At a Nov. 15 small-business forum, Ms. Schapiro said regulators were "working to implement the [JOBS] Act," but must proceed cautiously. By allowing entrepreneurs to advertise stock sales to the general public, for instance, she said Congress will bring a "fundamental change in the securities markets" that demand regulatory vigilance.

Heath Abshure, an Arkansas securities commissioner and president of the National American Securities Administrators Association, a securities industry trade group, says without proper oversight crowdfunding could hasten the return of unsavory operators selling bogus stocks to amateur investors.

"It's in both issuers' and investors' interests to take the time and make sure this is done right," he adds.

Write to Angus Loten at angus.loten@wsj.com

A version of this article appeared December 13, 2012, on page B1 in the U.S. edition of The Wall Street Journal, with the headline: Stalled Crowdfunding Rules Leave Business Plans on Ice.