A Common Scenario: you excitedly start your own company with an innovative concept just knowing you can change the world and become the next SnapChat, Uber or Net-a-Porter. But then you discover the unpleasant truth of angel investors and venture capitalists who don’t share in your vision and won’t return your calls – despite the uptick in startup ventures, it is still notoriously difficult to obtain funding.
Enter the magic wand in equity crowd-funding.
Thanks to President Obama’s JOBS Act – a law enacted with the express purpose of relaxing federal regulations to help spur, small, and startup business growth – equity crowd-funding will soon be available to any and all investors ostensibly without the imposition of the onerous capital formation rules of the Securities and Exchange Act (which requires an army of lawyers to draft disclosures, registration documents and maintain ongoing reporting obligations).
Equity crowd-funding may be more suitable than a rewards-based crow-funding model if your company is one that is not commodities based. With sites such as Kickstarter or Indiegogo, campaigners usually promote a specific product upon which their company is based that they then offer as a “reward” should the campaign succeed. That’s a little more difficult to do with, say, fashion companies, which are usually predicated on a range of garments and accessories or seasonal lines. Equity crowd-funding, however, enables companies to raise large amounts of capital – debt or equity – without providing tangible rewards at the end of a campaign.
Equity crowd-funding is currently only available on a limited basis as an exemption under the securities laws. Most notably, only “accredited” investors can invest in equity crowd-funding campaigns, “accredited” meaning people who have more than $1 million in net worth (not including their homes) or more than $200,000 in annual income. There are also strict advertising rules – the campaign generally cannot be advertised to non-accredited investors. That’s why even though there is an existing burgeoning equity crowd-funding community, we don’t really hear about it in the press.
The JOBS Act will dramatically change the landscape of equity crowd-funding and make it accessible to everyone from 18-year-old teenagers to all your family and friends. While the JOBS Act itself has officially been promulgated, the implementing rules – tasked to the Securities and Exchange Commission – have not. The SEC finally released its long-awaited 585-page proposed rules for its new “Regulation Crowdfunding” in late September, available here. While these will likely not kick in until at least the summer of 2014, you can and should prepare now to go all in and take advantage of what could be the most exciting development in capital formation in the last 50 years.
Based on the proposed rules, here are some tips to help you prepare to take advantage of the rapidly expanding equity crowd-funding market and successfully raise capital for your amazing new line without being slapped with a scary letter of inquiry from the SEC:
1. Be aware of the general limits on equity-funding campaigns:
• A company may offer only up to $1 million of “securities” in any 12-month period via a SEC-approved crowd-funding platform. This aggregate amount does not include offerings made under other capital formation channels such as Regulation D.
• Investors with annual incomes or a net worth below $100,000 can only invest $2,000 or 5% of their annual income or net worth, whichever is higher.
• Investors with annual incomes or a net worth above $100,000 can only invest up to 10% of that annual income or net worth.
• Crowd-funded securities are “restricted securities,” meaning they are subject to a one-year holding period except when transferred under certain strict circumstances.
2. The primary reason why you should start now in preparing to equity crowd-fund is: your company must have a legal structure (i.e., be incorporated) and have some financial history prior to starting the campaign – under the proposed rules, at least the following information must be first provided to the SEC, the crowd-funding platform, and your investors:
• The name, legal status and addresses of the business, along with the names of directors, officers and key shareholders.
• A business plan and description of the business.
• Financial information that may include income tax returns, officer-certified financial statements, and audited financial statements if raising $500,000 or more.
• A description of the purpose and intended use of the funds, the target offering amount and the price of the securities they’re offering.
• The ownership and capital structure of the business, including the terms of each class of the issuer’s securities and methods of valuation for the securities.
• Ongoing annual reports, financial statements, and disclosures.
That’s a demanding list of documents! Get started now in putting these together, it takes a lot of time and input from many people, including your accountant and lawyer, to complete them. And these documents must be meticulously drafted because…
3. …Your company and its officers, directors or partners, will be liable for any material misstatements or omissions:
Be scrupulously honest in all your documents, especially facts and figures, and err on the side of caution in disclosing everything. Any facts you submit or choose to ignore in your disclosures will put you at risk for a lawsuit and/or an investigation by the SEC. You definitely don’t want that, it will ruin all your hard work and set you up as a pariah in the business community. If in doubt, disclose. Understanding that our securities regime is one premised on disclosure will protect you and your company.
4. No advertising the campaign:
The proposed rules remain strict on advertising. You still generally cannot advertise to others regarding the campaign, aside from directing them to the intermediary website. You also cannot pay others to promote the campaign.
This means no posting about the campaign on Facebook or Twitter or sending out mass emails.
5. You must go through one, single, proper on-line intermediary:
Under the proposed laws, only an SEC-approved crowd-funding platform can be used and you can only use one to fund a campaign. Entities that will be known as “funding portals” and registered brokers are the only intermediaries through which you should be hosting your equity crowd-funding campaign. The SEC imposes separate rules on both classes of intermediaries and they are subject to strict regulations. Make sure that the company you want to host your campaign falls under either category.
That also means you should conduct your research now on which company you want to partner with! Over the next year, there will be an upsurge in the number of equity crowd-funding companies and all have different requirements and fee structures. Do your due diligence now and create a list of 5-10 companies you like…not all of them will choose to host your campaign.
6. You will not be able to equity crowd-fund if:
• You are incorporated outside of the U.S.;
• You are already a publicly-traded company or otherwise subject to the Exchange Act reporting requirements;
• You are an investment company;
• You have previously sold securities under the crowd-funding exemption but have not filed the requisite annual reports over the past 2 years;
• You have no specific business plan or have indicated that your business plan is to engage in a merger or acquisition with an unidentified company.
Now that you know the primary areas of limitation, you can reflect on the benefits of equity crowd-funding under the JOBS Act: it’s a fast way to access capital, it’s a good gauge of market receptivity to your business, and now you can get all your friends and family easily involved. This is truly an exciting time for startup companies. Access to capital will be greatly democratized under the new JOBS Act and we hope to see more talented companies bringing their innovations to the market. Will you be one of them?
This publication does not constitute the rendering of legal advice or other professional advice.