Crowdfunding: what is it?
Crowdfunding is a means for large groups of people to give small amounts of money for a particular cause. Websites like Kickstarter and IndieGoGo allow people to donate to a cause, company, or project, usually in exchange for free gifts, free products, or other fringe benefits. The federal JOBS Act enacted in March 2012 legalized equity crowdfunding subject to a number of legal requirements and regulations, which are currently being drafted by the Securities and Exchange Commission. Before the JOBS Act, receiving securities in exchange for small contributions was illegal or highly impractical.
Crowdfunding creates a new funding structure for issuers seeking up to $1 million, and it is anticipated that there will be restrictions on the amounts an investor may invest based on their annual income and net worth. The issuer must file with the SEC a comprehensive business plan, how the securities are valued, and financial statements. The issuer will have annual filing requirements with the SEC.
Crowdfunding is anticipated to be largely Internet-based and will use a structure that will have a funding portal intermediary or broker that must register with the SEC and FINRA. The portal will not be able to offer investment advice or solicit buyers. The portal must ensure that each investor understands the investment. The portal will be subject to the SEC’s reporting requirements with respect to each issuer. The portals will be responsible for implementing investor protections as directed by the SEC.
Foreign entities will not be able to use crowdfunding, because it will be available only to entities organized in the United States. Issuers and intermediaries will be subject to disqualification from crowdfunding for prior wrongdoing.
In order to strike a balance between allowing issuers to raise small amounts of capital and protecting investor rights, an issuer may sell a full amount to any investor over a 12-month period up to:
(i) the greater of $2,000 or 5 percent of such investor’s annual income or net worth, as applicable, if the investor’s annual income or net worth is less than $100,000; and
(ii) 10 percent of the annual income or net worth of said investor, as applicable, not to exceed a maximum total amount sold of $100,000, if the annual income or net worth of the investor is equal to or greater than $100,000. Net worth does not include the investor’s residence.
The issuer will be responsible for any misstatements, and the law requires the issuer to file information and financial statements with the Securities and Exchange Commission and provide investors and the Internet broker or funding portal, and make available to investors potential investors certain information, including, but not limited to:
1) the name, legal form, physical address and website address of the issuer;
2) the names of the directors and officers (and any person holding similar status or performing a similar function), and each person holding more than 20 percent of the issuer’s shares;
3) a description of the issuer’s business and the issuer’s anticipated business plan;
4) a description of the issuer’s financial condition, including any offers that, together with all other offers from the issuer within the preceding 12-month period, have, in aggregate, target offer amounts of $100,000 or less;
Likewise, 5) the income statements presented by the issuer for the last year ended (if any); and financial statements of the issuer, that if $100.00 or less is offered, they must be “certified” by the issuer as true and complete in all material respects, and that if the issuer has offered more than $100,000, but not more than $500,000, statements financial statements “reviewed” by a public accountant independent of the issuer, using professional standards and if the issuer has offered more than $500,000 (or such other amount as the SEC establishes, by rule), audited financial statements;
6) a description of the stated purpose and intended use of the proceeds of the solicited offer by the issuer with respect to the amount of the target offer; the amount of the target offer,
7) the deadline to reach the target offer amount and regular updates on the issuer’s progress in meeting the target offer amount;
8) the price to the public of the securities or the method of determining the price, provided that, prior to the sale, each investor is provided in writing with the final price and all required disclosures, with a reasonable opportunity to rescind the commitment buy the values
The buyer is obligated to keep the purchased securities for at least one year after the date of purchase. The JOBS Act required the SEC to promulgate final crowdfunding rules by December 31, 2012, but there are strong indications that the SEC will not have such rules in place by that date. Until the SEC publishes its final rules, equity crowdfunding is illegal.