Nothing says “Jumpstart Our Business Startups” more than crowdfunding, the seemingly new approach to raising capital over the Internet that has been the focus of much of the debate and criticism in connection with the legislative efforts that culminated in last week’s passage of the JOBS Act. In my mind, crowdfunding is not really something new, in that people have been soliciting funds from friends, family and those who share an interest for a long time (think, e.g., the March of Dimes) – this activity is now supercharged thanks to the power of the Internet and social media. As we noted in the July-August 2011 issue of The Corporate Counsel, until the JOBS Act came along, crowdfunding didn’t fit nicely into existing 1933 Act exemptions, and efforts have been underway for a few years to encourage the SEC to adopt a small offering exemption that was specifically tailored to crowdfunding.
The JOBS Act, after some debate resulting in an amendment to the crowdfunding title when the legislation was considered by the Senate, delivers on the promise of a 1933 Act exemption for crowdfunding, but with some strings attached in the name of investor protection. In particular, Title III, “Crowdfunding,” will amend Section 4 of the 1933 Act to add a new paragraph (6), which provides an exemption from registration subject to the conditions that: (1) the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the crowdfunding exemption during the 12-month period preceding the date of the transaction, is not more than $1,000,000; (2) the aggregate amount sold to any investor by the issuer, including any amount sold in reliance on the crowdfunding exemption during the 12-month period preceding the date of the transaction, does not exceed: (a) the greater of $2,000 or 5 percent of the annual income or net worth of the investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; or (b) 10 percent of the annual income or net worth of an investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000; (3) the transaction is conducted through a registered broker-dealer or funding portal that complies with the requirements of the exemption; and (4) the issuer complies with the requirements of the exemption.
The information requirements contemplated by the exemption ― which apply to both issuers and broker-dealers/funding portals ― are relatively steep, in that they contemplate providing information about risks (including asking questions of investors about risk), information about the issuer (including financial statements with varying levels of review/audit depending on the target amount raised), information about the offering (including a target amount where the issuer doesn’t receive the funds until the target amount is reached), and even ongoing SEC reporting after the offering is completed. The legislation contemplates the adoption of a whole new regulatory scheme applicable to the “funding portals” that host crowdfunding offerings, while at the same time giving those funding portals a break from full-blown broker-dealer registration. Intermediaries involved in crowdfunding offerings (or wanting to be involved in crowdfunding offerings) will need to figure out if they want to go with a broker-dealer model, or the presumably the more lightly regulated funding portal model.
But just in case you were getting excited to go out tomorrow and raise $1 million for a hot dog stand, note that the crowdfunding exemption leaves a lot for the SEC to determine through the rulemaking process. The JOBS Act directs the SEC to adopt implementing rules within 270 days of enactment, and who knows whether the SEC will be able to meet that deadline given the wide-ranging nature of this exemption and the seemingly obvious investor protection concerns that it raises.
Crowdfunding Gets an Association
Earlier this week, a collection of over fifty companies and individuals announced the formation of the National Crowdfunding Association. The NCFA is charged with “supporting, educating and protecting the American crowdfunding industry.” It is comprised of companies and individuals, funding portals, consultants and vendors to the industry. The group is going to hold its first National Crowdfunding Conference in July. Judging from my e-mail inbox these days, they are not going to be alone in holding crowdfunding events over the next few months.
Up Next: A Crowdfunding SRO?
A group is also seeking to establish a self-regulatory organization for the crowdfunding industry, to be dubbed the “Crowdfunding Industry Self Regulating Organization.” It is unclear at this time whether this effort will be successful and whether this group would ultimately become subject to SEC oversight. It will be very interesting to watch how this crowdfunding “industry” develops following enactment of the JOBS Act and the development of the SEC’s rules.
– Dave Lynn