On April 12, 2012 President Obama signed into law the Jumpstart Our Business Startups Act (commonly known as the JOBS Act) which was intended to enhance the ability of start-ups and smaller private businesses to attract funding from investors through “Crowdfunding”—which would involve solicitation by a company of funds through Internet fundraising portals. The actual implementation of the crowdfunding rules was delegated to the Securities and Exchange Commission (“SEC”) which has just announced final rules—Regulation Crowdfunding (click here to read more)–to allow companies to offer and sell shares through crowdfunding to a wide pool of potential investors. These new rules will become effective 180 days after they are published in the Federal Register, which should result in an effective date in mid-2016.

Before these new rules were finalized, only so-called accredited investors –typically wealthy individuals with an annual income of more than $200,000 or a net worth (excluding principal residence) of at least $1 million—were permitted to purchase shares in a private company in a crowdfunding offering. But under the new SEC rules, now basically anyone—regardless of income or net worth– will be able to invest in crowdfunding transactions subject to certain limitations discussed below.

Under the new SEC rules, a company can raise up to $1 million from all investors in a 12 month period through a crowdfunding offer without having to file a registration statement with the SEC under the federal securities laws. The crowdfunding will typically be done through postings on a single funding web portal which has registered with the SEC. Think Kickstarter, but instead of receiving goods or services, funders receive something potentially far more valuable–an equity stake in the listing company.

A company that engages in a crowdfunding offer will, however, be required to submit to the SEC and disclose to potential investors and the funding web portal financial statements and certain information about the company’s business, securities being offered, amount to be raised in the offering, how it will use the money raised, and its officers, directors and 20% owners. In addition, the company will need to file with the SEC and provide to investors an annual report.

If a company using the new equity crowdfunding rules fails to raise the full amount of its stated funding goal, it will be forced to terminate the offering and return all of the money which it raised in the offering, and will also lose its up-front out-of-pocket legal and other costs of its offering. Thus, setting a realistic investment target will need to be an important part of any company’s equity crowdfunding planning process.

Individual investors will be limited in the total amounts they can invest in all crowdfunding transactions in any 12 month period based on their income levels. People with an annual income or net worth of less than $100,000 may invest a maximum of the (i) greater of $2,000 or (ii) 5% of the lesser of their yearly income or net worth. And those with an annual income and net worth of $100,000 or more can invest up to 10 % of the lesser of annual income or net worth. But in no event can an individual invest more than $100,000 in all crowdfund offerings during a 12 month period.

Generally, investors may not resell shares purchased in a crowdfunding offering for one year after the purchase date.

Crowdfunding could prove to be an exciting new way for smaller companies to raise needed funds outside of the traditional financing sources such as venture capital and angel investors. While some commentators have warned that the costs and burdens of the crowdfunding reporting and disclosure requirements may discourage smaller companies from conducting crowdfunding offerings, only time will tell whether smaller companies will jump on the crowdfunding bandwagon to seek equity funding.

If you would like further information about whether crowdfunding might be useful to your business in raising capital, feel free to call or e-mail Norman Eule at neule@gcpc.com or 703-556-0411 .

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