- posted: Jan. 24, 2014
- Business Law,  Crowdfunding,  JOBS Act,  Jumpstart Our Business Startups Act
By Daniel Richardson
On April 5, 2012, the Jumpstart Our Business Startups Act (JOBS Act) became law. The JOBS Act seeks to “increase job creation and economic growth by improving access to the public capital markets for emerging growth companies.” Title III of the JOBS Act or the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012” addresses modifications to the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) to permit securities-based crowdfunding.
Crowdfunding is a method of raising funds through the Internet for a variety of projects ranging from innovative new products to artistic endeavors such as books or movies. Popular crowdfunding sites include Kickstarter, Indiegogo, and RocketHub. Crowdfunding, however, currently can not be used in the U.S. to raise money by selling ownership interests in a business, since securities that are not publicly traded or registered with the SEC must fall under one of the exemptions listed under Section 4 of the Securities Act. Title III of the JOBS Act added Section 4(a)(6) to the Securities Act, providing an exemption for businesses to raise money by offering an ownership interest in their business via crowdfunding.
Equity based crowdfunding has the potential to become a very powerful tool for startups and small businesses. Traditional debt financing, such as a business loan from a bank, can be difficult to obtain since many startups and small businesses do not have sufficient assets considered to be suitable to lend against or an established financial history. In addition, the financial covenants that are commonly included in a commercial loan’s terms can put limitations on management’s ability to run their business as they see fit. Similarly, while a business can obtain substantial amounts of capital through equity financing from venture capital and angel investors, many business owners end up giving up more control of their business than they had planned.
Equity crowdfunding could become a viable alternative to raising capital through debt financing or more traditional equity financing. Raising capital via crowdfunding, however, will not be as easy as posting your business on a site like Kickstarter and watching the funds roll in. First, companies cannot begin raising capital via crowdfunding until the comment period for the proposed crowdfunding rules ends on February 3, 2014 and the SEC issues its final rules (you can view the 578 pages of proposed rules at http://www.sec.gov/rules/proposed/2013/33-9470.pdf). The final crowdfunding rules could be out as early as this spring, but could take longer to go into effect.
Second, the amount of capital that can be raised via crowdfunding from investors for equity is limited under Section 4(a)(6) of the Exchange Act. A business will not be able raise more than $1 million during a 12-month period. The amount an investor can invest in one company in any 12-month period is also limited. Investors with an annual income of less than $100,000 can only invest the greater of $2,000 or 5% of their annual gross income into a business. If the investor’s annual gross income is greater than $100,000, the investor may invest up to 10% of his gross income, capped at $100,000.
Naturally, all businesses using this new crowdfunding method are required to make disclosures to the SEC and potential investors. Information that businesses participating in securities-based crowdfunding are required to provide include:
- The name, legal status, physical address, and website;
- The names of the officers, directors, and anyone holding a 20% or more ownership interest in the company;
- A description of the stated purpose and intended use of the proceeds from the offering;
- The target amount, the deadline to meet the target offering amount, and regular updates on the progress of meeting the targeted amount;
- The price of the securities and the method of determining the price;
- Company financials and tax returns; and,
- The terms of the securities.
Title III also establishes liability for material misstatements and omissions from the disclosure requirements. Securities sold under the Title III crowdfunding provision are also generally not transferrable for one year which may not be appealing to many investors.
Finally, securities-based crowdfunding must be conducted through a registered broker or a “registered funding portal.” Funding portals are a new exemption under the new Section 3(h) of the Exchange Act. To be exempt, the funding portal must be a member of a national securities association registered under Section 15A of the Exchange Act. The funding portals will only be intermediaries for transactions and will not be allowed to give investment advice, provide compensation for solicitation or sale of securities referenced on its portal or website, or manage, possess, or handle investor funds or securities. It is uncertain whether existing crowdfunding platforms, like Kickstarter, that specialize in donation and reward based crowdfunding will leverage their brand recognition and existing platforms to facilitate Section 4(a)(6) security-based crowdfunding offerings. Both new issuers and crowdfunding intermediaries should proceed with caution while entering into the early days of security-based crowd funding.
Despite the compliance issues over transferring equity through crowdfunding, start-ups and businesses lacking tangible assets could find securities-based crowdfunding an attractive source of financing. Crowdsourcing can potentially offer businesses access to capital without the collateral requirements traditionally associated with debt lending while allowing owners to maintain more control over their businesses than is often the case when dealing with angel financers or venture capitalists. With over $1.5 billion raised through crowdfunding platforms in just 2011, securities-based crowdsourcing could become a major player in the financing of startups and small businesses. Despite the many potential advantages, the rules for equity-based crowdfunding are brand new and raising funds through this avenue should be approached with caution and with the aid of experienced counsel.
ADVERTISING MATERIAL. The purpose of this article is to provide information on legal developments that may affect your business and is not to be considered advice nor does reading this content create an attorney-client relationship.
 15 USCS § 77e.
 15 USCS § 77d(a)(6)(A)
 15 USCS § 77d(a)(6)(B)
 15 USCS § 77d-1(b)
 15 USCS § 77d-1(c).
 Transfers may be made to the issuer of the securities, an accredited investor or family members of the purchaser. 15 USCS § 77d-1e(1).
 Currently, the Financial Industry Regulatory Authority (FINRA) is the only national securities association registered under the Exchange Act.
 15 USCS § 78c(a)(80
 Massolution, Crowdfunding Industry Report: Market Trends, Coposition and Crowdfunding Platforms (Abridged) (May 2012)
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