Many small-to-medium sized businesses urgently need equity capital but, because of legal restrictions and the expense of raising private venture capital, these firms often give up on traditional methods of capital raising. With great expectations, there was a change introduced in the new “Jumpstart Our Business Startups Act of 2012” (the “JOBS Act“) in April of 2012. The hope was that the JOBS Act would revolutionize the process and regulation of private capital raising via “Crowdfunding.” It is early yet in the process of the JOBS Act coming on line since the Securities and Exchange Commission has not published final regulations, despite the deadline for such regulations having passed on December 31, 2012. However, the early analysis shows both potential promise as well as potential aggravation for issuers, venture capitalists and investors. As John Wasik, author and contributor to Forbes and Reuters.com, asks: “The jury’s still out on whether the new JOBS Act will empower the next Steve Jobs or the next Bernie Madoff.” Our series will explore some of the issues involved with Crowdfunding and consider whether this will change equity capital raising as we know it or just be a shoulder shrug or something worse.
The concept of Crowdfunding is not unique to equity capital. It’s used in many different contexts: raising support for political campaigns, charitable causes, disaster relief, new software development, even scientific research. Internet sites such as Kickstarter and Indiegogo have been successful by providing sites that facilitate worldwide donations for ideas and fund raising. But the payments for these projects are gifts and not investments. In the world of corporate finance, it involves the use of the internet and social media to raise money, typically from a large number of people and in relatively small amounts, for investment in business enterprises. Crowdfunding enables small startup businesses that may not have easy access to traditional methods of capital formation, to raise capital quickly.
Raising capital from outside investors who are seeking a return on their investment through the efforts of others brings this activity squarely under the jurisdiction of federal and state securities laws, and the requirement to register the offering with the SEC under the Securities Act of 1933 (the “Securities Act“) unless an exemption to registration applies. Prior to the JOBS Act the exemptions to registration were not available for this type of funding. The Crowdfunding provisions of the JOBS Act are an attempt to offer a useable exemption from registration for such social media offerings. By using the internet and social media with limitless reach, Crowdfunding can raise complex federal, state and even non-US securities liability questions.
On April 5, 2012, President Obama signed the JOBS Act to expand and ease methods of capital formation by smaller companies. Title III of the JOBS Act introduces a new Section 4(6), providing a registration exemption for transactions involving the offer or sale of securities by an issuer, including all entities controlled by or under common control with the issuer, as long as the following conditions are met:
1. The total amount sold by the issuer to all investors, including amounts sold in reliance on this Crowdfunding exemption, during the preceding 12 months cannot exceed $1 million.
2. The total amount sold to any single investor by the issuer, including amounts sold in reliance on this Crowdfunding exemption, during the preceding 12 months cannot exceed:
if either the annual income or net worth of the investor is below $100,000, the greater of $2,000 or 5% of the annual income or net worth of that investor;
if either the annual income or net worth of the investor is $100,000 or more, 10% of the annual income or net worth of the investor (up to a maximum aggregate amount sold of $100,000).
3. The transaction is conducted through a broker or funding portal that complies with the requirements of new Section 4A(a) of the Securities Act.
4. The issuer complies with the requirements of new Section 4A(b) of the Securities Act.
New Section 4A(b) of the Securities Act requires each Crowdfunding issuer to file with the SEC, and to provide investors and the broker or funding portal certain disclosure information.
Our series will have much more to say about these requirements and the issues they raise.