Crowdfunding is a means for large groups of people to give small amounts of money for a particular cause. Websites like Kickstarter and IndieGoGo allow individuals to donate to a cause, company or project typically in exchange for gifts, free products, or other ancillary benefits. The Federal JOBS Act enacted in March 2012 legalized equity crowdfunding subject to a number of legal requirements and regulations, which are currently being drafted by the Securities Exchange Commission. Prior to the JOBS Act, receipt of securities in exchange for small contributions was illegal or highly impractical.
Crowdfunding creates a new financing structure for issuers seeking up to $1 million, and it is anticipated that there will be restrictions on the amounts an investor will be able to invest in accordance with their annual income and net worth. The issuer will be required to file with the SEC a comprehensive business plan, how the securities are valued, and financial statements. The issuer will have annual filing requirements with the SEC.
It is anticipated that Crowdfunding will be largely internet-based, and use a structure will have a funding portal intermediary or broker who must register with the SEC and FINRA. The portal will not be able to offer investment advice or solicit purchasers. The portal must ensure that each investor understands the investment. The portal will be subject to SEC reporting requirements with respect to each issuer. The portals will be charged with implementing investor protections as directed by the SEC.
Foreign entities will not be able to use crowdfunding, because it will be available only to entities organized in the United States. Issuers and intermediaries will be subject to disqualification from using crowdfunding for prior bad acts.
In order to strike a balance between enabling issuers to raise small amounts of capital and protect the rights of investors, an issuer is permitted to sell an aggregate amount to any investor during a 12-month period up to:
(i) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and
(ii) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000. Net worth does not include the investor’s residence.
The issuer will be liable for any misstatements, and the law requires the issuer to file information and financial statements with the Securities Exchange Commission and provide to investors and the internet broker or funding portal, and make available to potential investors certain information, including without limitation:
1) the name, legal status, physical address, and website address of the issuer;
2) the names of the directors and officers (and any persons occupying a similar status or performing a similar function), and each person holding more than 20 percent of the shares of the issuer;
3) a description of the business of the issuer and the anticipated business plan of the issuer;
4) a description of the financial condition of the issuer, including, for offerings that, together with all other offerings of the issuer within the preceding 12-month period, have, in the aggregate, target offering amounts of $100,000 or less;
Also, 5) the income tax returns filed by the issuer for the most recently completed year (if any); and financial statements of the issuer, which if $100,00 or less is offered, shall be “certified” by the issuer to be true and complete in all material respects, and which if the issuer has offered more than $100,000, but not more than $500,000, financial statements “reviewed” by a public accountant who is independent of the issuer, using professional standards and if the issuer has offered more than $500,000 (or such other amount as the SEC may establish, by rule), audited financial statements;
6) a description of the stated purpose and intended use of the proceeds of the offering sought by the issuer with respect to the target offering amount; the target offering amount,
7) the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target offering amount;
8) the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities.
The purchaser is required to hold the securities purchased for at least a year after the date of purchase. The JOBS Act required the SEC to enact the final rules for Crowdfunding by December 31, 2012, but there are strong indications that the SEC will not have such rules in place by that date. Until the SEC publishes its final rules, equity crowdfunding is unlawful.