WSJ | Louise Lee | May 1, 2016

A professor argues that lack of a secondary market for shares will deter buyers

Equity crowdfunding promises to be a major new source of funding for small businesses. But some critics say it lacks a crucial element: a secondary market for most participating investors.

Under the Jumpstart Our Business Startups Act, startups can sell equity stakes online to small investors with limited resources. It’s a potentially huge opportunity for businesses that might fly under the radar of bigger backers.

Many observers, though, have pointed out a possible flaw in the setup: There isn’t an easy way for those equity investors to sell their shares to somebody else. Without a secondary market, the critics say, equity crowdfunding won’t take off and small businesses won’t be able to tap all that capital.

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So far, the Securities and Exchange Commission hasn’t given the green light to a secondary market. Now Seth C. Oranburg, a visiting professor at Chicago-Kent College of Law, is pushing what he says is a way to jump-start the process: have crowdfunding portals hire analysts who would provide potential buyers with information about companies’ prospects and valuations. That way, he argues, a secondary market will be a much safer environment for unsophisticated small investors—and much more attractive for regulators to approve.

“The independent analyst is going to help people know what something is worth and make sure they’re selling it for the right price and buying it for the right price,” says Mr. Oranburg. “The SEC would hopefully permit a resale market to exist if they felt comfortable the private independent analyst would protect the resale investors.”

Protection for buyers

Although initial buyers also could benefit from analyst research, secondary buyers need that information even more, says Mr. Oranburg, whose paper on the topic will be published in a forthcoming issue of the Rutgers Law Journal. Under current laws, he says, secondary buyers don’t have as much protection from fraud as do initial investors.

He adds that although secondary buyers would have access to the public disclosures that startups are required to make, those filings aren’t enough and are likely to be too complicated for unsophisticated investors to understand.

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Mr. Oranburg sees each analyst covering as many as 30 startups listed with the portal, and protecting and advocating for shareholders by attending company board meetings and voting on certain matters such as acquisitions and management salaries. Ultimately, Mr. Oranburg says, these layers of protection provided by analysts should allow regulators to feel more comfortable with allowing secondary markets for crowdfunded shares.

In an email, an SEC spokeswoman said the commission wouldn’t comment. At a March 2015 meeting of the SEC’s Advisory Committee on Small and Emerging Companies, Commissioner Luis A. Aguilar said in a statement that didn’t speak for the agency, “The lack of a fair, liquid, and transparent secondary market for these securities is a long-standing problem that needs an effective solution.”

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support and networking opportunities to over 1300+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more About Us or visit ncfacanada.org.