Many of us have heard of crowdfunding thanks to fundraising platforms like Kickstarter orArtistShare. This type of crowdfunding was initially used to describe a request for seed or small mezzanine funding, largely through the Internet and other social media platforms, and allowed people donate funds to help venture a project initiated by other people or organizations. This type of crowdfunding treats funds as donations rather than investment, and “backers” get no return.

 The term crowdfunding, however, extends beyond the well-known donation-type funding, and has taken on a new and secondary meaning, which includes funding a company by selling a small amount of equity to many investors (“equity crowdfunding”). Entrepreneurs and others see this form of crowdfunding as a good way of securing investments, but this practice importantly raises the possibility of getting ensnared in various securities laws, since soliciting investments from the general public is most often illegal unless the opportunity has been filed with an appropriate securities regulatory authority, such as the Securities and Exchange Commission (“SEC”). Access to equity driven crowdfunding may soon become easier, however, due to recent revisions to the JOBS Act, which awaits implementation in 2014.

 This past October, the SEC proposed a series of amendments (Title III JOBS Act), which would permit public solicitation in connection with unregistered offerings of private equity, and include unaccredited investors – a practice that previously has not been permitted. These revised rules are expected to take effect early next year, and will be available to entrepreneurs and start-up companies looking for investors and looking to solicit over the Internet. This “crowdfunding proposal,” if adopted by the SEC would ultimately be a major game changer in how small U.S. companies raise money in the private securities market.

Under current law, private companies are allowed to solicit from only accredited investors – those with a net worth of at least one million dollars, excluding the value of their homes, or annual income of more than $200,000. The new amendment, however, would allow small businesses to raise up to one million dollars ($1,000,000) per year from unaccredited investors.

 In drafting the proposed amendments, the SEC has had to strike a balance between facilitating crowdfunding, and protecting investors against fraud, and in doing so, the SEC endeavored to avoid “additional unnecessary frictions to the marketplace.” (quoting SEC Republican Commissioner Daniel Gallagher). Striking this balance included new SEC rules imposing numerous disclosures and other requirements on small companies and crowdfunding intermediaries, which will be critical for any entrepreneur or small business interested in taking advantage of equity-driven crowdfunding to understand. Important among these requirements are the following:

• Companies using crowdfunding must raise money through regulated broker-dealers such as Circleup or through crowdfunding portals (a new regulatory category at the SEC).
• Crowdfunding portals will be required to provide companies with educational materials and take steps to reduce fraud risk.
• Companies utilizing crowdfunding will be required to make certain disclosures, including information regarding officers, directors, use of proceeds, and financial statements.
• The amount of money an unaccredited investor can contribute annually will be capped based on certain income thresholds. Specifically, investors with a net worth and income of less the $100,000 will be limited in what they can contribute to $2,000 or 5% of their net worth or income (whichever is greater), but those with a net worth or income more than $100,000 may contribute more.

 There is hope that these rules will make it easier to for entrepreneurs and small companies to raise capital, but it will be important for anyone seeking to raise funds via crowdfunding under the new regulations to seek attorneys knowledgeable about the new rules and regulations. Violations of rules and regulation can be painful and potentially financially ruinous for a start-up and its founders.

Please don’t hesitate to contact us with any questions about the new regulations, and stay tuned for an update in 2014 on the implemented final rules!