Regulation Crowdfunding:  Is It Right For You?

Startups guide to the new regulations of crowdfunding

The new rules for crowdfunding issued by the U.S. Securities and Exchange Commission (SEC) on October 30, 2015 generated a lot of excitement around the possibility of using crowdfunding to raise capital from equity investors.  For years, entrepreneurs and others have used crowdfunding portals such as Kickstarter and Indiegogo to raise funds for their projects and ventures, but how is “regulation crowdfunding” different and is it right for creative entrepreneurs?

The SEC issued its crowdfunding rules under Title III of the JOBS Act.  The JOBS Act was intended to stimulate growth in the startup economy and required the SEC to issue rules that would provide startups with easier access to capital to help stimulate that growth.  The SEC’s crowdfunding rules go into effect May 16, 2016.

Finding the right investors is essential to every startup. To put the new rules in context, it is helpful to have some basic education in securities law.  After the stock market crash of 1929, the U.S. Congress enacted the Securities Act of 1933 which requires that certain disclosures be made when offering securities (stock, notes, bonds, etc.) and provides penalties for making false or misleading statements in connection with securities offerings.  At about the same time, Congress passed the Securities Exchange Act of 1934 which regulates public securities markets and established the SEC.  The SEC functions as an investor protection bureau and its rules are intended to help investors make informed investment decisions and to protect them against abuse.  The basic premise of the SEC’s regulations is that an offer or sale of securities must be registered with the SEC unless the particular security or transaction is exempt from registration under the SEC’s rules.  Because registration and ongoing compliance are costly, most startups rely on the exemptions from registration provided by SEC Regulation D, including, in particular, the exemption from registration for a transaction in which only “accredited investors” participate. Accredited investors are generally high net worth individuals, trusts, banks and other companies owned solely by accredited investors. By its nature, crowdfunding attracts all types of investors, most of whom do not qualify as accredited investors.

Title III and the new crowdfunding rules attempt to make investing available to ALL investors and even the smallest companies.  The new rules provide an exemption from SEC registration for securities offerings of not more than $1,000,000 in any 12-month period.  An investor in a regulation crowdfunding offering is limited to investing up to $2,000 or 5% of his or her annual income or net worth if his or her annual income or net worth is less than $100,000. If the investor’s annual income or net worth is equal to or greater than $100,000, the investor is limited to investing the lesser of $100,000 or 10% of annual income or net worth.  The transaction must be conducted through a registered broker or funding portal and the company must file a Form C with the SEC and provide a copy to each prospective investor.  The company will also be subject to ongoing reporting requirements with the SEC and each investor, including, in some cases, a requirement that audited financial statements be filed with the SEC.

While regulation crowdfunding may open access to capital not previously accessible to creative entrepreneurs, it also comes with burdensome and Crowdfunding is on the rise and can benefit many startups, if regulations are followedexpensive filing and reporting requirements.  Regulation crowdfunding portals must be registered and are subject to their own complex reporting requirements, the costs of which will likely be passed through to companies offering securities through those portals.  In this complex environment, creative entrepreneurs should gain an understanding of all fundraising options available to them before following the crowd.

Next month’s blog post will provide a general overview of traditional Regulation D equity offerings, which have been used by startups since the 1980s.

DISCLAIMER:  No attorney-client relationship is intended to be established with any person or entity by the distribution of the information in this blog post and no such relationship may be inferred.  Readers should consult counsel and other advisors when considering an offering of securities.

Debbie Ramirez is an attorney with the Modrall Sperling Law Firm in New Mexico.  She has worked with companies and venture capitalists and regularly guides clients through the complex world of capital-raising.

 

 

About the author

Debbie Ramirez

Debbie RamirezDebbie Ramirez is an attorney with the Modrall Sperling Law Firm in New Mexico. She has worked with companies and venture capitalists and regularly guides clients through the complex world of capital-raising. http://www.modrall.com/DeboraRamirez  @DebbieRamirezNM