While the Jumpstart Our Business Startups Act (the “Act”) has recently been signed into law, collecting small sums of money from the general public over the Internet is not a new phenomenon. Crowdfunding or crowdsourcing has been around for a few years. In the past, the majority of the Crowdfunding sites catered to one time creative events such as a concert series, or were used by charities to raise money.
Previously, the sale of an equity interest was registerable under the Securities Act of 1933, as amended (“1933 Act”), unless the security or the transaction was exempt.
The Act provides for a funding exemption from the Securities and Exchange Commission (“SEC”) registration requirements for certain offerings with the following limitations.
(A) the aggregate amount sold within the previous 12-month period in reliance upon this exemption is: (i) $1,000,000, as such amount is adjusted by the SEC to reflect the annual change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics, or less; or (ii) if the issuer provides potential investors with audited financial statements, $2,000,000, as such amount is adjusted by the SEC to reflect the annual change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics, or less.
(B) the aggregate amount sold to any investor in reliance on this exemption within the previous 12-month period does not exceed the lesser of: (i) $10,000, as such amount is adjusted by the SEC to reflect the annual change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics; and (ii) 10% of such investor’s annual income.
When Congress passed the Act, lawmakers left it up to the SEC to determine the mechanics of how such transactions will actually work. The SEC started taking public comments in May.
In that the SEC has 270 days to implement the regulation; your company will not be able to use the Crowdfunding exemption until early 2013. Until then, federal and state securities law prohibitions remain in place against publicly accessible Internet securities offerings.
New Hampshire based companies or companies looking to raise money in the state must continue to comply with the current state securities law requirements. The Act only exempts equity offerings from federal securities law registration requirements. Also, the requirements of federal and state securities laws regarding disclosures, including disclosures of all material facts and risks to investors, will remain in place.
Issues to Consider
1. Prior Raises
If your company has raised more than a $1 million in the last 12 months, then your company will not qualify for the crowdfunding exemption.
2. Disclosure Requirements
The Act does not relieve your company from disclosure requirements. The requirement to disclose all material facts and risk factors to investors will remain in place. Failure to do so may expose your company to liability for securities fraud, private lawsuits and administrative enforcement actions.
Be aware of anyone or any company offering to collect a fee in exchange for help in raising capital over the Internet. Because the Act has not been implemented, such offers could be a scam, preying upon those entrepreneurs less familiar with the Act’s requirements
4. Communication Plan
Communicating with hundreds of “owners” may distract management from devoting the time and energy that is necessary to run a successful business. Your company will need an effective communication plan.
5. Keeping Your Secrets
Some companies don’t want to share a business plan or idea without requiring a non-disclosure agreement. However, your company will need to give potential investors enough information to make an informed decision and to allow the potential investor to preform their due diligence: company name, address, information about the management team, a business plan and description of the business, and the intended use of the funds raised must still be disclosed.
6. Financial Disclosure
If you don’t want your competitors to see how your company is doing, then you may not want your financials made public. But if you Crowdfund, you may need to provide different amounts of financial information to your investors depending on the amount you are attempting to raise.
7. You Still Need Professional Advice
The investments you receive through Crowdfunding will be for equity in your company, so you will need to have a lawyer structure the deal and set up the necessary funding documents. It would be ideal to have a Private Placement Memo that would disclose all of the risks to potential investors.
8. Up-Front Costs
There are a lot of costs that you will incur before placing your opportunity online for potential investors. If you are only raising a small amount, the Crowdfunding may not be a cost effective option.
Paul D. Creme is an attorney with Hamblett & Kerrigan PA. His practice is focused on business and corporate law. Of particular interest are the areas of software and emerging technologies. You can reach Attorney Creme at [email protected].