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, or were used by charities to raise money. Two examples of this type of site are Kickstarter and IndieGoGo.
Generally, equity interests in businesses in return for a capital investment to help businesses operate and grow are registerable under the Securities Act of 1933 (“1933 Act”), unless the security or the transaction is exempt. Crowdfunding, by its definition, does not fall within the current exemptions available under the 1933 Act. The main obstacle is that the offer to invest cannot be circulated to the general public; it must be offered only to a select group of potential sophisticated investors. When a company uses a website, however, anyone with Internet access would have the opportunity to invest.
This all may change with the recent passage by the House of Representatives of the Entrepreneur Access to Capital Act (HR 2930). The bill, authored by Patrick McHenry of North Carolina has the backing of both parties as well as the White House.
The bill provides for a funding exemption from the Securities and Exchange registration requirements for certain offerings with some 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 Commission 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 Commission 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 Commission to reflect the annual change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics; and
(ii) 10 percent of such investor’s annual income.
Senator Scott Brown of Massachusetts introduced a separate bill in the Senate on November 9th of this year with some small differences. His bill places lower thresholds on investment as one way to mitigate potential fraud.
Both bills bear watching. While Crowdfunding would provide another source of equity funding for small businesses, there are several potential drawbacks for entrepreneurs. Unlike contributions to one-off projects in which donors have no say in implementation, equity investors want, and are entitled to, some influence in the direction a business takes. Having hundreds of equity investors means you will be answering to hundreds of bosses. That’s time-consuming and costly to administer. Moreover, startups that accept equity Crowdfunding can expect to have difficulty raising additional funds from venture capital firms and other sophisticated investors if they have hundreds of small, less knowledgeable backers.
However, with the potential enactment of either bill or a combination thereof, this may still become an alternative way to fund your start-up company.
If you have any questions or would like additional information on this issue or other corporate challenges, please contact Paul D. Creme.
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 firstname.lastname@example.org.