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The New Crowdfunding Rules

On October 30, 2015, the Securities and Exchange Commission (“SEC”) adopted rules allowing the use of crowdfunding by companies to offer and sell securities. Crowdfunding is the raising of money in cyberspace through portals, i.e., specialized websites like Gofundme, Indiegogo, Kickstarter. By using these portals, individuals or businesses can engage in fundraising in order to promote ideas to a large group of potential investors.  Crowdfunding has become a handy tool in new projects since it is another method for a small business to raise capital.  The SEC is seeking to regulate these practices and to protect investors since startups and entrepreneurs can raise capital through this revolutionary method.

For example, Title III of the Jumpstart Our Business Startups (“JOBS”) Act created an exemption in the securities laws to allow crowdfunding to be used for offering and selling securities. The exemption called for the final rules, Regulation Crowdfunding, to administer such offerings and sales. The rules allow for crowdfunding securities transactions within certain limits. The limits include the amount that could be raised through crowdfunding, requirement of disclosure of certain information to investors, and creation of a regulatory framework for the funding portals, which facilitate the transactions.

In essence, some of the rules are:

  • Companies can only raise $1 million through crowdfunding in a 12-month period
  • If the investor’s annual income or net worth is less than $100,000, he/she is limited to the greater of either: (a) $2,000; or (b) 5% of the lesser of his/her annual income or net worth
  • If the investor’s annual income or net worth is equal to or more than $100,000, he/she can only invest 10% of the lesser of the annual income or net worth

The rules also indicate that certain companies will not be eligible for exemptions under Title III.  These companies include non-U.S. companies and commercial entities that have no specific business plan.  Another restriction is that securities cannot be resold for one year.  Furthermore, all relevant transactions must be done through an SEC-registered intermediary.

The information that must be disclosed, includes, but may not be limited to, the following:

  • The company’s financial condition
  • Method for determining price
  • Target offering amount and deadline
  • Financial statements

The rules would require the intermediary to: (i) provide educational material that explains the process of investing, types of securities offered, and information a company must provide; (ii) provide communication channels for discussions about offerings; and (iii) disclose to investors the compensation the intermediary receives for the transaction.

The rules also prohibit the intermediaries from the following: (i) providing a platform for a company that has potential for fraud or other investor protection concerns; (ii) having a financial interest in a company that is offering or selling securities on its platform that is not meant for compensation for its services; and (iii) compensating a person for providing the intermediary with sensitive information of an investor or potential investor.

At this time, Regulation Crowdfunding will be effective 180 days after its publication in the Federal Register. However, forms that allow portals to register with the SEC would be effective on January 29, 2016.

At our law firm, we assist clients with legal issues related to business start ups, conducting business over the internet, and more. You may contact us to set up an initial consultation.