Fred has a problem. He is an entrepreneur with a bright idea, but lacks the money to get the business off the ground. Unfortunately, the bank is not interested, and Fred long ago exhausted the interest of his relatives and friends in any of his ideas. Feeling terribly discouraged, Fred hears about “crowdfunding” and the federal Jumpstart Our Business Startups (JOBS) Act. Fred sees this as a gift from heaven. Is Fred right?
Crowdfunding is a phenomenon of the Internet. Utilizing the web’s ability to contact millions of people at an instant, promoters of worthy causes have raised money by simply asking for it. Other than supporting the worthy cause, little or nothing was promised in exchange for a typically small contribution. The tactic has been used very successfully to support, among other things, non-profit charitable ventures, musical groups, disaster relief, and motion pictures. The idea was thus born that the “wisdom of the crowd” would judge the cause; thumbs-up delivered by a million clicks or no thumbs should the crowd be unimpressed.
It was only a matter of time before the Freds of the world, large and small, would come to view crowdfunding as a way to raise capital for their worthy businesses. The JOBS Act embraces crowdfunding in the context of the federal securities laws and appears as a genuine effort on the part of Congress to make raising capital from individual investors available to entrepreneurs like Fred whose resources would not, at least until now, allow access to the financial markets. In October 2013, the SEC released proposed regulations to implement the crowdfunding provisions of the JOBS Act and impose certain limits, disclosures, and requirements on Fred and his entrepreneurial colleagues, including, but not limited to, the following:
Investment Limits: Fred cannot raise more than $1 million in a 12-month span, while individuals are limited in the amount they can invest on a sliding scale based on their net worth (excluding personal residence) or annual income. Ultimately, investment caps can be as low as $2,000 or as high as $100,000.
Required Disclosures: Fred must disclose, among other things, a business plan, the entity’s financial condition, the amount requested, funding progress updates, and the designated use of the requested funds.
Continuous Reporting: At least annually post-offering, Fred must provide financial statements to investors, which will be prepared to various levels of accountant scrutiny based on the offering size.
Education: Fred must present factors that make the investment speculative or risky. However, the primary education burden falls on the chosen internet intermediary to inform investors of the risks associated with investing in securities sold via crowdfunding, including the risk of total loss.
While awaiting the finalized federal regulations, the State of Wisconsin recently got into the act with the Crowdfunding and Securities Exemptions (CASE) for JOBS Act, hopefully in a way that will broaden and not limit Fred’s opportunities. Specifically, higher limits for offering amounts and individual investments are allowed for offerings from Wisconsin businesses solely to Wisconsin residents. Crowdfunding will be available under CASE beginning in June 2014.
Fred has reason to be hopeful, but it is too early to pop the champagne as there is a great deal that needs to develop. For example, the internet intermediary called for by Congress may play an important role in guiding Fred and others like him through the process – or not – in which case potentially large and even prohibitive consulting costs may be involved. Additionally, the cost feasibility of the disclosure requirements may render crowdfunding unusable for start-ups. At this point, the optimist would think that Fred will be able to comply and be successful. The pessimist would tell Fred that his chances of actually raising money are very small while the liability risks are high. The devil will be in the details, and such details will be delivered by the SEC when it adopts final crowdfunding regulations following the close of the three-month comment period in January 2014.
If you have any questions about how the information in this article may affect you or your business, please contact Ron Todd at firstname.lastname@example.org or (608) 257‑2281 or your Stroud attorney.
DISCLAIMER: The information in this article is provided for general informational purposes only, is not necessarily updated to account for changes in the law, and should not be considered tax or legal advice. This article is not intended to create, nor does the receipt of it constitute, an attorney-client relationship. You should consult with your own legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.