New JOBS Act brings Crowdfunding to Start-up Companies

With President Obama signing the Jumpstart Our Business Startups (JOBS) Act on April 5, the word “crowdfunding” is getting a lot of attention by start-up companies and potential investors. Just what is crowdfunding? Generally, it is a process whereby an individual or start-up company uses the internet and social media to raise capital in relatively small amounts from a large number of people. This potentially game-changing way to raise capital will now be governed under the new Act.

Title III of the Act creates a new exemption under Section 4 of the Securities Act for crowdfunding offerings as long as certain criteria are met. They are:

(A) no more than $1,000,000 is raised via crowdfunding in any 12 month period; and

(B) no single investor invests more than a specified amount in the offering, namely:

i. the greater of $2,000 or 5% of the annual income or net worth of the investor, as applicable, if the investor has annual income or net worth of less than $100,000; or

ii. 10% of the annual income or net worth of the investor, as applicable, if either the annual income or net worth of the investor is equal to more than $100,000, capped at a max of $100,000 invested.

(C) the offering is conducted through a registered broker or “funding portal”; and

(D) the issuer complies with certain other requirements that are detailed in the Act.

For example, an investor who makes $30,000 per year (or who has $30,000 in net worth) can invest up to $2000 in crowdfunding campaigns in a given year. If an investor’s income or net worth is $80,000, then he/she can invest up to $4,000. With an annual income or net worth of $100,000 or more, then he/she can invest 10% of his/her annual income/net worth, up to a maximum of $100,000 (in the case that their income or net worth is $1,000,000).

Like most issues, crowdfunding has its supporters as well as its critics. A few of the pros of crowdfunding include:

  1. More money for startups. Unquestionably, the greatest benefit for new businesses is that they can raise money from anyone. The general public can also benefit. If you really like a particular company, you might want to invest in it. Before the JOBS Act you couldn’t; now you just might be able to do so.

  2. More investors jumping into the pool. Crowdfunding might encourage accredited investors to get more active with startups; currently fewer than 5% of them do. And crowdfunded opportunities might be the easy, low-risk investment that inexperienced investors unaccustomed to startups will use to become comfortable putting money into all startup vehicles. Thus, the JOBS Act might eventually increase the amount of capital available for private businesses of all sizes.

  3. Less onerous Sarbanes-Oxley paperwork. For companies ready to go public, the JOBS Act streamlines the process. Some firms, like those with under $1 billion in revenues, can now go public without following all the Sarbanes-Oxley compliance and disclosure regulations, at least for the first five years on the public markets. Avoiding these expensive and burdensome regulations can help young companies conserve their cash while safeguarding sensitive information or trade secrets during the ramp up to IPO. This should be a benefit to strong but small companies as they access the public market.

On the other hand, crowdfunding has some drawbacks:

  1. A field day for scammers. Where there's money, there's fraud. Not every business seeking crowdfunding dollars will be legitimate, but it may not be easy to tell the difference between scams and real startups. Self-regulation in the crowdfunding arena will be critical and several groups are working to come up with methods to prevent crowdfund investors from getting bilked. There's a 270-day initial regulation-writing period during which this is all supposed to get sorted out. It won't be easy, and it may not be possible to foresee all the clever ways scammers will be able to rip people off.

  2. Nanna might lose her retirement nest egg . For new, inexperienced investors, crowdfunding may be a nightmare. Most businesses fail, and all the money in the world won’t change that. While there are limits to the amounts that an individual can invest and thus lose, many unsavvy investors still won’t be prepared to see their investments, no matter how small, wiped out.

  3. Investors will still have to do their own due diligence. While there are already many directories and "portals" of crowdfunding opportunities, they are all severely limited as to the information they can reveal to users. They cannot make recommendations on investments so they cannot rank companies, score opportunities, or offer editorial advice. Companies will be able to put their information out to consumer investors, but it will be difficult for investors to rate the companies against each other.

Companies must go through an intermediary (a “funding portal”) to crowdfund, and those intermediaries must be registered with the Securities Exchange Commission. Eight crowdfunding sites to watch include: Kickstarter, Crowdtilt, AngelList, Crowdfunder, WeFunder, Indiegogo, MicroVentures, and SecondMarket.

Start-up companies and investors interested in crowdfunding will be well advised to carefully consider its immediate and long-term implications. For more information and analysis on crowdfunding, including requirements applicable to funding portals, we suggest the following links: http://us.practicallaw.com and http://fundinglaunchpad.com/2012/04/investment-crowdfunding-legislation-review/

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