November 13, 2013
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Sebastian Gomez Abero and Jessica Dickerson, Division of Corporate Finance
Subject: File No. S7-09-13, Proposed Rule on Crowdfunding
Dear Sir or Madam,
My name is Matthew Platkin and I am a student at Stanford Law School. This comment focuses on the definition of “predecessor” in the context of the $1 million aggregate funding limit for crowdfunding issuers. The proposed rule includes predecessors of the issuer in the definition of “issuer” for the purpose of the aggregate funding limit. While there is legitimate concern that a company will simply reorganize in order to avoid the $1 million cap, it is equally true that in the small business and startup context, there is an abnormally high rate of failure and reorganization amongst young companies. The finalized rules should clearly limit this particular definition of predecessor to those reorganizations that are done for no other purpose than to evade the crowdfunding cap.
The term “predecessor” is not clearly defined in relation to issuers of a 4(a)(6) offering. In the context of funding portals, the proposed rule requires a successor funding portal to be one that shares a “legitimate connection” with the predecessor, such that it “assumes or acquires substantially all of the assets and liabilities of the predecessor funding portal’s business.” (Crowdfunding, 78 Fed. Reg. 66427 (proposed Nov. 5, 2013) (to be codified at 17 C.F.R. pt. 200) (referencing pp. 204-05).) Other interpretations of the 1933 and 1934 Securities Acts have similarly defined “predecessor.” (Reg. 12b-2, 17 CFR 240.12b-2, http://www.law.cornell.edu/cfr/text/17/240.12b-2/.)
Such a definition, if applied to issuers of 4(a)6) offerings, would frustrate the purpose of the exemption. As described on page 17 of the proposed rule, the intent of the exemption is to “provide an additional mechanism for capital raising for startup and small businesses. . . .” (Crowdfunding, 78 Fed. Reg. 66427 (proposed Nov. 5, 2013) (to be codified at 17 C.F.R. pt. 200) (referencing pp. 204-05) (referencing p. 17).) A rule pertaining to small businesses and startups must account for the fact that, historically, nearly a quarter of such businesses fail within the course of their first year. (Bureau of Labor Statistics, Entrepreneurship and the U.S. Economy, http://www.bls.gov/bdm/entrepreneurship/bdm_chart3.htm (last visited November 11, 2013).)
The story of Twitter, the latest highly successful startup to IPO, is instructive. Twitter started as a side project within another startup, Odeo. (Nick Bilton, All is Fair in Love and Twitter, N.Y. Times, October 9, 2013, available at http://www.nytimes.com/2013/10/13/magazine/all-is-fair-in-love-and-twitter.html?pagewanted=1&_r=1.) After a series of power struggles during Twitter’s first year—which included the resignation of the individual who founded both Twitter and Odeo—several Odeo employees ultimately acquired it. If Odeo had issued $1 million in 4(a)(6) securities during the year prior to Twitter’s founding, it is possible that, under the proposed rule, Twitter would have been precluded from issuing 4(a)(6) securities of its own.
The crowdfunding exception formalized by 4(a)(6) is intended to provide small businesses and startups with an alternative source of capital. In doing so, it should take into account the dynamic, and often chaotic, nature of these businesses during their early years. As such, a more effective rule would limit the predecessor definition for purposes of the $1 million limit on issuers to those reorganizations whose intent is to avoid the cap altogether.