Equity Crowdfunding

Article provided and reprinted with permission by Lloyd Lee, PC.

What is Equity Crowdfunding?

Equity crowdfunding means raising capital from the crowd in exchange for equity in a company. The current SEC rules permit businesses to raise capital online from accredited investors only. However, once the SEC releases its new rules, small-to-medium sized businesses will soon be able to raise capital on the internet from non-accredited investors in exchange for equity. The game is about to change – enter the JOBS Act.

What is the JOBS Act?

In April 2012, President Obama signed into law the Jumpstart Our Businesses Act (JOBS Act) which will allow businesses to raise capital from non-accredited investors online in exchange for equity. In more technical terms, Title III of the JOBS Act amends Section 4 of the Securities Act to create a new exemption for offerings of “crowdfunded” securities.

The SEC is currently trying to figure out a way to regulate equity crowdfunding for non-accredited investors. There are many problems associated with this new medium for capital formation including the risk of fraud. Hence the SEC is being very careful before releasing regulations permitting equity crowdfunding from non-accredited investors.

What are some of the Rules?

  1. Companies will be permitted to raise up to $1 million per twelve-month period;
  2. Non-accredited investors may invest the greater of $2000 or 5 percent of the annual income or net worth of such investors, if either the annual income or the net worth of the investors is less than $100,000;
  3. The transaction must be conducted through a licensed broker-dealer or funding portal that complies with section 4A of Title III;
  4. Companies seeking to raise capital must register with the SEC and meet strict disclosure requirements including the purposes for which the funds will be used, valuation methodologies, and many other important business and risk factors. The disclosure requirements are similar to a private placement offering memorandum which requires the services of a competent corporate attorney;
  5. To reduce the risk of fraud, each officer, director, and any shareholder owning more than 20% of the outstanding equity of the company must submit to a background check;
  6. Companies must provide a 21-day safe harbor period for investors to review disclosures and marketing materials;
  7. No funds will be transferred until the company meets it’s fundraising target;
  8. Companies cannot pay referral fees to agents, promoters, or lead generators who find investors;
  9. Companies must also provide investors with an annual report of financial performance;
  10. Investors cannot transfer their equity within 12 months of purchase subject to limited exceptions.

This is not a comprehensive or finalized list. The SEC will release specific rules and regulations in the near future.

How will Crowdfunding Change the Game?

The power of the crowd is undeniable. Just look at non-equity companies like Kickstarter and Indiegogo and the success that people have achieved in raising funds for projects. Sites like Kickstarter and Indiegogo allow people to transfer monetary gifts but the donors do not receive equity because it is not yet permitted.

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