Crowdfunding: Key Points and Legal Criteria
Business crowdfunding has been legalized through the Jumpstart Our Business Startups Act (JOBS Act) which was passed by Congress and signed into law by Pres. Obama in April 2012. The JOBS Act now enables businesses to solicit securities-based funding from the general public. Business crowdfunding as outlined through the JOBS Act allows investors to receive a financial return through the purchase of equity, debt or revenue based securities. General crowdfunding as seen on most crowdfunding portal websites such as kick starter is based on the donation model which does not allow for any return on funds invested. These donations are received to create new projects but do not allow for securities based returns. The JOBS Act expands investment opportunities to nonaccredited investors, every American will have access to investing in startups and small business.
Legislation and Regulation
- Certified Public Accountant: Legislation requires an audit by an accredited CPA for funds raised exceeding $500,000 and a review by a CPA for funds raised in excess of $100,000.
- Attorneys: though not required by any statute are generally considered necessary to draft documents pertaining to the security arrangements of the venture. Additionally, structuring the entity to correspond with all criteria of the business model keeping with it in the legal structure allowed for the JOBS Act.
- Funding: The JOBS Act bill states that all transactions must be completed through a funding portal or broker. These portal fees are expected to range from 5 to 8% of the transaction.
- Large firms such as the big 8, can charge as much as $20,000 minimum to start. Certified reviews can range from $5000 and up.
- The company will be able to crowdfund up to $1 million over a 12 month period.
- Investors can fund one company or several companies as long as they remain within these annual limits.
- Companies crowdfunding will be exempt from the 500 shareholder cap pursuant to rules and regulations of the SEC.
- A crowdfunding round does not prevent a company from raising capital through other legal channels.
- Crowdfunding portals or websites must, alongside the legally required background checks, must do a full review of the company, disclosures and the raise in order to approve a company prior to fundraising.
- Minimum Review & Checks: Companies that seek to crowdfund a securities-based round must have background checks done on all principles with 10% or greater ownership in the company and provide full and adequate disclosures with a business plan and a full description of their ownership and capital structure.
- Individuals with an annual income or net worth of less than $100,000 may invest up to $2,000 or 5 percent of their annual income or their net worth, whichever is greater, over a 12 month period. Individuals with an annual income or a net worth of $100,000 or more may invest up to 10% of annual income or net worth, capped at $100,000 maximum aggregate amount, over a 12 month period.
- An investor must wait a minimum of 12 months before selling her/his securities unless the sale is to a family member, the issuing company, or an accredited investor, in addition to other restrictions normally placed on the transfer of securities.
Provisions of the Bill
- Increase the number of shareholders a company may have before being required to register its common stock with the SEC and become a publicly reporting company. These requirements are now generally triggered when a company′s assets reach $10 million and it has 500 shareholders of record. The House bill would alter this so that the threshold is reached only if the company has 500 “unaccredited" shareholders, or 2,000 total shareholders, including both accredited and unaccredited shareholders.
- Provide a new exemption from the requirement to register public offerings with the SEC, for certain types of small offerings, subject to several conditions. This exemption would allow use of the internet "funding portals" registered with the government, the use of which in private placements is extremely limited by current law. One of the conditions of this exemption is a yearly aggregate limit on the amount each person may invest in offerings of this type, tiered by the person's net worth or yearly income. The limits are $2,000 or 5% (whichever is greater) for people earning (or worth) up to $100,000, and $10,000 or 10% (whichever is less) for people earning (or worth) $100,000 or more. This exemption is intended to allow a form of equity crowdfunding. While there are already many types of exemptions, most exempt offerings, especially those conducted using the internet, are offered only to accredited investors, or limit the number of non-accredited investors who are allowed to participate, due to the legal restrictions place on private placements of securities. Additionally, the Bill mandates reviews of financial statements for offerings between $100,000 and $500,000, and audits of financial statements for offerings greater than $500,000 (noting maximum offering of $1,000,000).
- Define "emerging growth companies" as those with less than $1 billion total annual gross revenues in their most recent fiscal year.
- Relieve emerging growth companies from certain regulatory and disclosure requirements in the registration statement they originally file when they go public, and for a period of five years after that. The most significant relief provided is from obligations imposed by Section 404 of the Sarbanes-Oxley Act and related rules and regulations. New public companies now have a two-year phase-in, so this bill would extend that by an additional three years. Smaller public companies are also already entitled to special relief from these requirements, and the bill does not change that.
- Lift the ban on “general solicitation” and advertising in specific kinds of private placements of securities. This allows broader marketing of placements, as long as companies only sell to accredited investors (based on income, net worth or written confirmation from a specified third party).
- Raise the limit for securities offerings exempted under Regulation A from $5 million to $50 million, thereby allowing for larger fundraising efforts under this simplified regulation.
- Raise the number of permitted shareholders in community banks from 500 to 2,000.
- The bill prohibits the crowdfunding of investment funds.
Titles of the Bill:
TITLE I - REOPENING AMERICAN CAPITAL MARKETS TO EMERGING GROWTH COMPANIES
TITLE II - ACCESS TO CAPITAL FOR JOB CREATORS
TITLE III - CROWDFUNDING
TITLE IV - SMALL COMPANY CAPITAL FORMATION TITLE V - PRIVATE COMPANY FLEXIBILITY AND GROWTH
TITLE VI - CAPITAL EXPANSION TITLE VII - OUTREACH ON CHANGES TO THE LAW
Current Status (source: Wikipedia)
Titles I, V, and VI of the JOBS Act became effective immediately upon enactment. The SEC approved the lifting of the general solicitation ban on July 10, 2013, paving the way for the adoption of Title II. As of October 2014, Titles III, and IV are awaiting more rulemaking by the SEC. Title III rules were proposed for adoption by the SEC on October 23, 2013. As of December 26, 2014, this is the latest news "The Securities and Exchange Commission recently released a rulemaking agenda revealing that it plans to finalize the Title III Equity Crowdfunding rules and the Title IV Regulation A+ rules from the JOBS Act by October 2015. Given that these rules will then require 60 days to be published in the federal register and become law, it appears likely that the earliest date small businesses will be able to utilize these JOBS Act provisions to raise capital will be the beginning of 2016."