Crowdfunding: What is it?

Crowdfunding: What is it?

Crowdfunding: What is it?

Crowdfunding is a means for large groups of people to give small amounts of money to a cause. Websites like Kickstarter and IndieGoGo allow people to donate to a cause, company, or project, usually in exchange for gifts, free products, or other ancillary benefits. The federal JOBS Act passed in March 2012 legalized equity crowdfunding, subject to a number of statutory requirements and regulations currently being drafted by the Securities and Exchange Commission. Before the JOBS Act, receiving securities in exchange for small contributions was illegal or highly impractical.

The crowdfunding creates a new funding structure for issuers seeking up to $1 million and is expected to have limits on the amounts an investor will be able to invest according to 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.

Crowdfunding is expected to be largely Internet-based and uses a structure that will have an intermediary or funding portal broker that must register with the SEC and FINRA. The portal will not be able to offer investment advice or solicit buyers. The portal should ensure that every investor understands the investment. The Portal will be subject to SEC reporting requirements with respect to each issuer. Portals will be tasked with implementing investor protection as per SEC guidelines.

Foreign entities will not be able to use crowdfunding as it will only be available to entities organized in the United States. Issuers and intermediaries will be disqualified from using crowdfunding for past bad actions.

In order to strike a balance between the ability of issuers to raise small amounts of capital and the protection of investors’ rights, the issuer is allowed to sell an aggregate amount to each investor within a 12-month period of up to:

(i) the greater of $2,000 or 5 percent of such investor’s annual income or net worth, as applicable, if the investor’s annual income or net worth is less than $100,000; and

(ii) 10 percent of such investor’s annual income or net worth, as applicable, not to exceed the maximum aggregate amount sold of $100,000 if the investor’s annual income or net worth is equal to or greater than $100,000. The net worth shall not includes the investor’s residence.

The issuer will be liable for any misrepresentations and the law requires the issuer to file information and financial statements with the Securities Exchange Commission and make them available to investors and the Internet broker or funding portal, and to provide potential investors with 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 all persons occupying a similar status or performing a similar function), and any person who owns more than 20 percent of the shares of the issuer;

3) description of the activity of the issuer and the expected business plan of the issuer;

4) a description of the financial condition of the issuer, including for offers that, together with all other offers of the issuer within the preceding 12-month period, have aggregate target offering amounts of $100,000 or less;

Also, 5) the income tax returns filed by the issuer for the last completed year (if any); and financial statements of the issuer, which, if $100.00 or less are offered, must 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 of $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 reports;

6) a description of the stated purpose and intended use of the offering proceeds sought by the issuer in relation to the target offering amount; the target bid amount,

7) the deadline for reaching the target offering amount and regular updates on the issuer’s progress in achieving the target offering amount;

8) the public price of the securities or the method of determining the price, provided that before the sale, each investor is provided in writing with the final price and all necessary disclosures, with a reasonable possibility to cancel the commitment to purchase the securities.

The buyer is required to hold the purchased securities for at least one year after the date of purchase. The JOBS Act requires the SEC to adopt final crowdfunding rules by December 31, 2012, but there are strong indications that the SEC will not enact such rules by that date. Until the SEC publishes its final rules, equity crowdfunding is illegal.

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