Washington warms to "crowdfunding" for startups

WASHINGTON (Reuters) - Bipartisan support is growing to allow private companies to quickly tap thousands of small investors through a strategy called “crowdfunding.”

The Obama administration and Republican lawmakers have drafted legislation that would let investors take small stakes in private startups over the Internet, touting it as a way to supercharge job growth and innovation.

The U.S. Securities and Exchange Commission is also considering revamping its offering rules, but is taking a cautious approach. It fears that loosening registration rules could open the door to fraud and weaken investor protections.

On Wednesday, Republican Representative Patrick McHenry proposed legislation to relax SEC disclosure rules on public offerings by companies seeking crowdfunding.

Under his bill, an unlimited number of investors could contribute up to $5 million to crowdfunded companies, but could not individually contribute more than $10,000 or 10 percent of their annual incomes.

The bill would also exclude crowdfunding investors from the 499-shareholder cap for private companies and remove the ban on general solicitation that exists in many current exemptions.

It follows a similar proposal by President Barack Obama included in the jobs bill he delivered to Congress this week.

“In an economic environment in which lending to job creators and entrepreneurs remains dismal, we must find new and modern means for capital formation to ignite our sputtering economy,” said McHenry at a House Oversight subcommittee hearing on Thursday examining crowdfunding.

As Congress considers loosening capital-raising restrictions, the SEC is also reviewing its own rules to see if they need to be updated to encourage capital formation while also protecting ordinary investors from risky schemes.

The issue jumped into the spotlight recently as Wall Street banks and electronic markets offer investors a chance to buy and actively trade stakes in hot Internet companies such as Facebook and Twitter before they go public.

Privately held companies generally are bound by the 500-shareholder rule, which states that once a company has that many shareholders of record -- and at least $10 million in assets -- it must make the same financial disclosures as a public company.

But changes in securities markets have allowed companies to find ways around the restrictions, prompting SEC Chairman Mary Schapiro to ask staff to study the agency’s offering rules.

Meredith Cross, the director of corporation finance at the SEC, said at the hearing on Thursday that the SEC has not reached any conclusions about how, or if, to update its capital-raising rules for private companies.

Regarding crowdfunding, she said an exemption could provide “real benefits,” but disclosures would be necessary to protect investors.

“If it’s viewed as a tainted market where people go to fraudulently steal money that won’t help anyone,” she said. “I worry about websites popping up all over the place and disappearing and then the money is gone.”

More broadly, Cross said the SEC is also reviewing the ban on general solicitation and the cap of 499 shareholders for private companies.

Earlier this week, the SEC announced the creation of a panel composed of up to 20 private sector representatives, including an executive from social games maker Zynga, who will advise the agency on issues such as capital raising, trading in the securities of fast-growing companies and the public reporting of those companies.

Reporting by Alexandra Alper; editing by John Wallace and Tim Dobbyn