Three’s a crowd: the SEC and the FCA look to regulate crowdfunding

by DLA Piper

[author: Dylan Kennet t] 

On 24 October, the United States Securities and Exchange Commission (SEC) unanimously supported the idea that rules be proposed under the Jumpstart Our Business Startups Act (JOBS Act) so that start-ups could offer and sell securities through the medium of crowdfunding.  For the uninitiated, crowdfunding is a method of raising capital through selling varying levels of equity to a large number of investors over the internet.   Crowdfunding grew in popularity by raising money for artists to realise their projects, but quickly moved to a means to fund small businesses. Notable, (and contentious) crowdfunding successes include Zach Braff for his movie, ‘Wish I Was Here’ and for the newest Spike Lee ‘joint’ on Kickstarter. 

This announcement presents a big step in the United States to recognise crowdfunding as a legitimate method to raise capital.  Within the JOBS Act, Title III created an exemption to bypass the provisions which govern selling securities to individuals.  This aims to address what many see as a funding gap for start-ups between the ‘family and friends’ round of funding to the seed round.

Under the proposed rules:

• A company could raise up to a maximum aggregate amount of $1 million through crowdfunding over a twelve month period.

Investors over a twelve month period could invest up to:

• $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

•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 the twelve month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

Investors are to be protected through the regulation of intermediaries.  Under the JOBS Act there is a condition that crowdfunding transactions occur on SEC approved and registered platforms, referred to as a ‘funding portals’ (i.e. Kickstarter et al.).  Thus, intermediaries will be obligated to, inter alia, educate investors, take active measures to limit the potential of fraud, as well as, provide information on the securities being issued and the issuer themselves.

Not to be outdone in the UK, on the same day the Financial Conduct Authority (FCA) released consultation paper 13/13 on their approach to crowdfunding and ‘similar activities’.  The consultation is partly in preparation for their takeover of regulation of the consumer credit market from the Office of Fair Trading. 

Amongst proposals outlined in the paper are requirements such as, crowdfunding portals shall restrict sales to ‘sophisticated’ investors; and limiting crowdfunding investment to 10% of an investor’s total portfolio.  This is in conjunction with the requirement to disclose important information about the investment, thereby using education as a safeguard for investors. 

The FCA posits that this reflects a prudent position in a market where ‘…100% capital loss is more likely than not…’ and 50-70% of new businesses fail in their early years.  It will be of interest to see the response to the consultation paper, as the proposals could be seen as in direct conflict of the democratic nature of crowdfunding by espousing restrictions on the type of investor that could participate; that is those investors who are ‘sophisticated’ and of high net worth.

Nonetheless, it seems this model has the backing of many important stakeholders going forward. Seedrs made waves in May with a competition called the ‘Million Pound Startup’ to source crowd funds to invest in a high-growth technology company to be based in Tech City.  Supporters included the City of London, UK Trade and Investment and the UK Business Angels Association, as well as a number of professional services whose overall aim is to incubate and accelerate the winning business.  The take home message is that crowdfunding is now clearly a genuine means for start-ups to build their business and the announcements from both the SEC and FCA adds further legitimacy to this exciting and egalitarian method of finance.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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