In October, the SEC released a 585-page document that proposes rules for crowdfunding under Title III of the Jumpstart Our Business Startups Act (JOBS Act). To be fair, about 20 pages refer to letters of comment from various legislators and government agencies, so you’d read only about 560 pages.
The JOBS Act was enacted in April of 2012 specifically for small businesses and startups to raise capital in exchange for securities through Internet-based crowdfunding platforms. Most of the well-known crowdfunding platforms – Kickstarter and Indiegogo, for example – facilitate crowdfunding through gift- and reward-based backing. Anyone can give money to startups on these sites, and in exchange they receive goods, services or a simple thank-you. Title III rules would allow these sites to broker equity deals between investors and entrepreneurs.
Before JOBS Act
Existing SEC crowdfunding rules (pre-JOBS Act, but still in place) fall under the registration requirements of Section 5 of the Securities Act of 1933 (the “Act”), which:
- Don’t work well for businesses that wanted to raise smaller amounts of capital
- Don’t allow fundraisers to give ownership shares in exchange for contributions without invoking the SEC’s securities regulations
- Require websites that facilitate these types of transactions to register with the SEC as a broker/dealer
Title III Proposals
Title III Proposes amending Section 4 of the Act, creating an additional class of “crowdfunded” securities that are not subject to the registration requirements of Section 5, if funds raised are less than $1 million in a 12-month period. It also limits individual investors to contributions of $2,000 or 5 percent of their annual income or net worth if they make or are worth less than $100,000 a year; individuals who make or are worth more than $100,000 are limited to 10 percent of annual income or net worth. It also prohibits resale of the securities within one year of purchase.
In addition, it requires the third party that facilitates the transaction to register as a broker or under a new status called “funding portal.” These third parties would be required to:
- Give investors access to educational materials
- Reduce risk of fraud
- Provide channels for communication between investors and businesses
In addition, they would not be allowed to give investment advice, solicit transactions to buy securities presented on their websites, pay people for solicitations or handle investor funds in any way.
Startups asking for equity-based crowdfunds would be required to publicly disclose:
- Information about owners, officers and owners who hold 20 percent or more stake
- What they intend to do with the money
- Price, fundraising goal, deadlines and whether they will accept contributions in excess of their goals
- Financial condition of the startup, including financial statements, tax returns or results of an independent audit
Alternatively, startups can continue to utilize existing exemptions for financing efforts.