SEC Released Crowdfunding Rules

Years ago a client approached me about raising money on the internet for his business through a then-relatively new concept called crowdfunding.  As you probably know, crowdfunding uses the Internet and social media to solicit relatively small sums from large numbers of people. Companies and individuals are using it to raise money for products, projects, medical help, or nonprofit ventures.  Backers typically get a thank you, free product or other trinket.

The reasonable extension of the concept is raising capital by selling stock in your company on the internet.  “No way,” said the SEC, leaving me to tell my clients pretty much the same for years because under the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. The Act provides companies with a number of exemptions. For some of the exemptions, such as rules 505 and506 of Regulation D, a company may sell its securities to what are known as “accredited investors.”  The time and expense associated with the regulatory framework has kept many small businesses from such offerings.

Last Wednesday, the Securities & Exchange Commission voted unanimously to propose rules that, for the first time, would allow investors to buy stock in companies over the Internet using a crowdfunding exchange.  The rules were authorized in The Jumpstart Our Small Business Startups Act, passed by Congress in early 2012.  A provision in the “Jobs Act” created an exemption to the rules mentioned in the previous paragraph that will allow privately held companies sell up to $1 million a year in unregistered securities to investors who need not be accredited; however, the amount an investor may contribute to such deals is limited.  Under the proposed rules, any investor, over a 12-month period, could invest up to:

(1) $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000, or

(2) 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During a 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

Under the rules, companies that sell unregistered stock to accredited investors must take steps to verify their income and net worth requirements. But the provider of the portal on which a business is listed does not need to verify its investor status.  This interesting paradox illustrates the complexity of the issue, which pits capitalism in the age of the internet against protection of so-called “mom & pop” investors.  Investors as well as companies seeking to attract capital are wise to consult with their accounting and legal advisors.

The promulgation of the rules is nearly a year behind schedule, and a final rule is probably not likely for another 6-10 months.   Plenty of time to dust off that business plan.

Credit where credit is due. Some of the information above came from  USA Today and San Francisco Chronicle.  

About Chris McGrath

I'm a Carmel, Indiana business attorney providing business counsel, commercial litigation and mediation services based on over 20 years of experience. My firm is founded on a principle of supporting others' advancement and achievement, and my core values are service, passion, faith & loyalty.Chris McGrath's Google+ Profile