Will Money from the crowd finally be available for entrepreneurs?

Equity Crowdfunding has been in the gestation stage for many years.  Congress first paved the legal way for equity crowdfunding when it enacted the Jumpstart Our Business Startups (“JOBS”) Act in April 2012.  Equity crowdfunding – the sale of equity securities by a business to the “crowd” through an internet portal – differs greatly from the now mainstream capital raising activity known simply as crowdfunding where all sorts of organizations, projects or people use the power of websites like Kickstarter and Indiegogo to raise money for projects, causes or organizations.  While the JOBS Act ordered the Securities and Exchange Commission (SEC) to promulgate rules and regulations for equity crowdfunding, the SEC has been slow to act. The SEC’s slow implementation of workable equity crowdfunding rules and regulations inspired many states, including Minnesota, to enact state equity crowdfunding legislation.

So has Equity Crowdfunding’s time has finally come?

The SEC’s final rules on equity crowdfunding become effective on May 16, 2016. Under the JOBS Act and the SEC’s final rules:

  • $1 Million Limit. Companies can raise up to $1 million in a 12-month period through equity crowdfunding.  If a company wants to raise more money, there are still other options, such as Regulation A+ mini-IPO.
  • Investor Limits. An individual member of the crowd can invest (a) the greater of $2,000 or 5 percent of the lesser of their annual income or net worth, if either the annual income or the net worth of the investor is less than $100,000 and (b) 10 percent of the lesser of their annual income or net worth, if both the annual income and net worth of the investor is equal to or more than $100,000. In either case, an investor may not invest more than an aggregate amount of $100,000 in one year.
  • Risk of Forfeiture. If a company attempting to raise money through equity crowdfunding does not raise the full amount of their funding goal, the company does not get to keep any of the money raised and loses out-of-pocket up-front costs.
  • Financial Statement Requirements. A company raising money through equity crowdfunding must have reviewed financial statements to raise more than $100,000, and lesser financial disclosures when raising less than $100,000.
  • Disclosure Requirements. A company must disclose to investors (and file with the SEC) the price of the equity securities sold, the method for determining the price, the target offering amount, the deadline to reach the target and whether the company will accept investments in excess of the target.  Disclosure must also include a discussion of the company’s financial condition, a description of the business and the use of proceeds from the offering, information about officers and directors and owners of 20 percent or more of the company and annual financial statements.
  • No Secondary Market. Much like most shares sold through private placements, the shares sold in equity crowdfunding cannot be sold (in most circumstances) for at least one year. There is no marketplace or exchange for these shares, and in all likelihood, never will be unless a company registers with the SEC and becomes a public company.
  • Crowdfunding Portals. A company raising money in reliance on the equity crowdfunding rules must conduct its offering through a registered funding portal and must conduct its offering exclusively through only one intermediary platform at a time. There are complicated rules and compliance obligations for crowdfunding portals.
  • Liability for Misrepresentations. Equity crowdfunding involves the sale of securities, and not just pre-selling a gadget like on Kickstarter. The federal and state laws that govern the sale of securities still apply so if a company is untruthful in its materials or disclosure or otherwise violates these rules, the company (and its officers and directors) can be sued, and in some cases, these officers and directors can face criminal prosecution.

An opportunity for startups to raise capital by way of the sale of equity securities through the internet has never existed before.  It goes without saying that there will be costs (some substantial) to equity crowdfund a startup business.  Legal fees, compliance costs, funding portal fees, broker-dealer fees, and marketing expenses will add up. It will take entrepreneurial minded attorneys offering affordable services and innovative businesses offering compliance services for a reasonable cost for equity crowdfunding to take hold.  In the near term, however, capital probably will still be out of reach for most young companies.