Crowdfunding describes an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a variety of projects ranging from innovative product ideas to artistic endeavors like movies or music. Title III of the JOBS Act created an exemption under the securities laws so that this type of funding method can be easily used to offer and sell securities as well. The JOBS Act also established the foundation for a regulatory structure for this funding method.
Entrepreneurs and start-up companies looking for investors will be able to solicit over the Internet from the general public under a new proposal issued by the SEC. The “crowdfunding” proposal, if adopted by the Securities and Exchange Commission, would be a major shift in how small U.S. companies can raise money in the private securities market.
Private companies are currently allowed to solicit only accredited investors, those with a net worth of at least $1 million, excluding the value of their homes, or annual income of more than $200,000. The crowdfunding rule would let small businesses raise up to $1 million a year by tapping unaccredited investors.
It remains to be seen if the plan goes far enough in limiting regulatory costs so that small businesses find crowdfunding desirable.
The measure would still impose a number of disclosure rules and other requirements on small companies and crowdfunding intermediaries.
Rory Eakin, the chief operating officer and founder of CircleUp, a brokerage that offers crowdfunding opportunities to high-net-worth “accredited” investors, said he was initially optimistic about the proposal until he read the fine print. “It’s hard to imagine attractive companies will take advantage of these proposed rules,” he said, citing a raft of concerns including a requirement for companies to file financial statements every year.
SEC commissioners said on Wednesday they hope the plan strikes the right balance between facilitating crowdfunding and protecting investors from possible fraud.
The public will have 90 days to respond to the proposal, which is hundreds of pages long.
“I believe our proposal is generally careful not to add additional, unnecessary frictions into this marketplace,” SEC Republican Commissioner Daniel Gallagher said. “That said, the proof is always in the pudding.”
Alon Hillel-Tuch, a co-founder and chief financial officer at RocketHub, a crowdfunding platform that is considering registering with the SEC, said that overall he was optimistic about the SEC’s plan. At the same time, he is concerned about aspects of the proposal, such as a requirement that a company raising more than $500,000 provide an audited financial statement.
Some small companies have no historical financials, making it hard to figure out how they would be audited under U.S. accounting standards, Hillel-Tuch said.
The JOBS ACT: The SEC’s crowdfunding plan is a requirement in the Jumpstart Our Business Startups (JOBS) Act, a 2012 law enacted with wide bipartisan support that relaxes federal regulations to help spur small business growth.
The rule was supposed to be completed 270 days after the law was enacted, but it has been delayed at the SEC by leadership changes, a heavy workload and the difficulties in crafting a workable crowdfunding proposal.
As part of an investor protection measure in the JOBS Act, companies using crowdfunding will still be required to raise the money through regulated broker-dealers, such as CircleUp, or through crowdfunding portals, a new regulatory category at the SEC.
The crowdfunding portals will most likely be self-policed by Wall Street’s industry-funded watchdog, the Financial Industry Regulatory Authority, which unveiled its own parallel set of proposed rules recently.
How many entities might register as crowdfunding portals or brokers is not known. In an early, tentative estimate, the SEC said anywhere from 50 to 100 brokers and portals could initially seek to enter the space after the rule is adopted.
Under the SEC’s proposal, crowdfunding portals would be required to provide investors with educational materials and take certain steps to reduce the risk of fraud.
Companies using crowdfunding would also have to make some disclosures about their businesses, such as information about officers and directors, how proceeds from the offering will be used, and financial statements. In addition, the proposal limits how much money an unaccredited investor can contribute each year, based on certain income thresholds.
The proposal says that investors with a net worth and income of less than $100,000 can contribute only $2,000 or 5 percent of their net worth or income, whichever is greater. Those with a net worth or income of more than $100,000 can contribute more.
In an effort to reduce burdens on companies and portals, the SEC’s plan would not explicitly force them to take steps to verify the income levels and net worth of investors in crowdfunding. At the same time, the SEC plan would require companies using crowdfunding to release financial statements and other information that could prove costly.
Mat Dellorso, the founder and chief executive of WealthForge, a brokerage involved in crowdfunding, said he saw the SEC’s plan as being “middle of the road” with very few surprises, and that he was happy to see the agency making progress.
“Experienced entrepreneurs will have no problem navigating the crowdfunding rules, nor will the intermediaries,” he said. “It is the first-time entrepreneurs that will need help.”