Crowdfunding is one of the words I hear business clients ask about the most. Boulder and Denver are two of the most entrepreneurial environments in the country with start-ups popping up all the time. Crowdfunding is a means which allows start-ups to raise money without the expensive and time-consuming requirements of a typical securities offering. The JOBS (Jumpstart Our Business Startups Act) was passed in 2012 and one of the components of this act required the SEC to ease many regulations, especially those that affect smaller, new businesses.
Previously, the SEC required equity offerings to be registered with their agency. While there are a number of different methods of registering, all of them are costly, time-consuming, and usually too onerous for small businesses to even consider. Furthermore, investors were required to have a certain income. The process could be complicated by the state in which the investing individual lives. Annual reports, disclosures, and audits needed to be submitted to the SEC. The offering documents alone could easily cost tens of thousands of dollars, which is typically not financially feasible for new companies. Without a simpler means to facilitate raising capital for small businesses, the chances of success were extremely slim.
Websites like Kickstarter had already existed for some time, but investors to Kickstarter projects do not buy equity in the company under this model. They simply donate money and based on the amount they donate, the company provides a product or service to the individual at a later date once it is up and running. Crowdfunding is a similar idea, except it allows investors to invest small amounts of money. The requirements for who may invest, which companies may utilize crowdfunding, and other regulations have been relaxed significantly.
Some of the key points in the recent proposed crowdfunding rules include that companies may only raise up to 1 million dollars per year using crowdfunding. Investors earning less or who’s net worth is less than one hundred thousand dollars are limited to the higher of two thousand dollars or five percent of their net income. For investors earning over one hundred thousand dollars, they may invest up to 10% of their net income, not to exceed one hundred thousand dollars.
Another interesting requirement of the new proposed rules is the use of investment portals. These portals are intended to act as a defense against investor fraud. The portals are not permitted to provide investment advice but instead can outline the risks and potential rewards for less sophisticated investors. They can offer educational materials and take additional steps to prevent investor fraud.
One requirement that is not favorable to the companies is that the offering documents are still required. In traditional offerings, documents such as private placement memorandum must be compiled and distributed to potential investors. There are a myriad of legal requirements that speak to what must be included in the offering documents but generally they must outline risks and potential benefits, give backgrounds on the company’s officers, financial data, etc. These offering documents are extremely costly and will still be required for companies who elect to crowdfund.
Crowdfunding is a great new way for companies to raise smaller amounts of money and avoid registering with the SEC. While this does avoid some expense, there are still a variety of requirements that need to be adhered to. Companies that reach over 2,000 owners will no longer be allowed to crowdfund and are required to register with the SEC. The advantage is that the company can usually find funding and allow the founders to retain a large amount equity. If you’re thinking about crowdfunding, you should consult with an experienced business and securities attorney to assist you in navigating the new, extensive, and always changing regulatory framework.