Crowdfunding and Your Business

In March, Congress passed the controversial Jumpstart Our Business Startups Act (JOBS Act), Public Law 112-106, and President Obama signed the bill into law on April 5, 2012. The Act is designed to stimulate job creation (and, by extension, the economy) by helping emerging companies get better access to capital. This post explores some of the changes to crowdfunding brought about by the Act and what you might consider in deciding whether crowdfunding is right for your business.

First and foremost, this bill made crowdfunding legal. Before, it was (and still is) illegal. But wait, you may ask, what about sites like Kickstarter and IndieGoGo? Are they illegal? No; crowdfunding in the sense we are speaking of here means allowing unaccredited investors (read: people who are not rich) to invest in new and emerging companies that are not publicly traded. Both Kickstarter and IndieGoGo allow people to give money to others in exchange for a product or service (or nothing) to be provided in the future, as opposed to in exchange for an ownership interest in a company. Now small business owners, too, will be able to receive investments from the public, and members of the public will be able to become part-owners of the smallest of companies.

The JOBS Act allows greater access to funding by small companies (it calls them “emerging growth companies” and defines them as companies with less than $1,000,000,000 in annual revenue, if they did not have their initial public offering on or before December 8, 2011) in large part by deregulating them—giving them selected exemptions to the reporting, advertising, and other requirements of the Securities Exchange Acts of 1933 and 1934, as well as the Sarbanes-Oxley Act. It also gives a framework for operations of companies that will deal in emerging growth company securities, including brokers and the newly-created category of funding portals.

These funding portals are subject to some, but not all, of the same regulations as brokers, likely because a funding portal is far more limited in the functions it can perform — little more than selling emerging growth company securities. No matter which type of intermediary is involved, the intermediary will have a great many disclosure requirements as well as obligations to ensure certain protections are in place for investors. Emerging growth companies, as issuers of securities through these intermediaries, will have to provide a great deal of information in preparation for receiving investments. All crowdfunding will have to go through a broker or a funding portal.

If you have a small business, here are some highlights you should be aware of:

• It will now be possible to receive up to $1 million per year in funding from investors who are not accredited. Anyone from your parents to strangers will be able to invest in your company.
• You still cannot advertise a crowdfunding offering, except to direct people to the broker or funding portal that is supporting your securities offering.
• You must ensure that information you provide to your broker or funding portal, which is then passed on to investors, is complete and correct. The JOBS Act lists some of the information that will need to be provided and gives the SEC authority to require additional disclosures.
• When you seek investments, you will be required to select a target, and you will not be able to receive any funds at all unless you reach your investment target amount (think Kickstarter).
• All officers, directors, and major shareholders of your company will be subject to background checks before you can list your securities offering.
• Your broker’s or funding portal’s officers, directors, or partners will not be able to have a financial interest in your company.
• You will need to make an annual report to the SEC and to your investors regarding your operating results and financial statements.
• If you meet all of the requirements, your offering will be exempt from state blue sky laws, which are the state equivalent of the Securities Exchange Acts.
• Securities you sell in a crowdfunding offering cannot be transferred for a year, unless they are transferred back to your company, to an accredited investor, to a family member, or in connection with the death or divorce of the investor. The SEC has the option to impose additional restrictions.
• Crowdfunding is available only to domestic companies that are not investment companies and are not reporting companies under the Securities Exchange Acts.
• The SEC has, in several places, the authority to promulgate whatever regulations it believes are needed. The statute gives the SEC 270 days, or 9 months, to create the regulations. They are subject to public comment both now and upon release.

Are you still interested in crowdfunding after reading all of that? Here are some more things to consider in deciding whether crowdfunding is right for your business:

• The wait. If your company is in need of funds now, crowdfunding is not the way to go. It is likely to take at least a year to a year and a half before there are any crowdfunding opportunities.
• The expense. Overall, complying with the disclosure requirements could be prohibitively expensive for companies in the earliest stages. The SEC has publicly stated its displeasure with several aspects of the JOBS Act and is widely expected to use its rule-making authority to create substantial barriers to crowdfunding.
• Communicating with investors. You know how anxious your friends and family are to hear about how your business is going now? Imagine how much worse they would be if they had money riding on the outcome. Small investors, like many small business owners, are likely to be very emotionally invested in the outcome of your business and may be more likely to sue than larger investors if things do not go as planned.
• The responsibilities. You may see crowdfunding as an opportunity to bring on some money without being beholden to an angel investor or venture capitalist. But once you take on investors, no matter how small they are, you will have responsibilities to them. Minority stakeholders have rights—make sure you know what those are and how they will affect your operations before you decide you want a few.

Do you think crowdfunding will be right for your company, or are you waiting to see what the SEC regulations look like before deciding?