Crowdfunding and the Jobs Act

Crowdfunding involves the use of the Internet to solicit and raise money from the general public (the “Crowd”) in order to fund a project or projects. Small amounts of money are typically received from a large number of non-accredited investors and contributors.

The amount of money raised can be as little as a few dollars to the total amount requested by the company, if not more. Crowdfunding is a relatively new and evolving method of raising capital to support a wide rage of ideas and ventures.

Crowd members typically congregate online sharing information & concerns ultimately assisting one another in deciding whether to fund /invest or not – the “wisdom of the crowd”

Types of crowdfunding

• Non-equity crowdfunding: In return for the contribution the funder either receives nothing (treated as a donation) or a non-financial token or reward such as a sample of the product or a ticket to a performance or the like.
• Equity crowdfunding: In return for a contribution or investment the funder may receive an equity or financial stake in the business or certain contributions can also be structured as loans with the expectation of repayment.

Does crowdfunding result in the sale of security?

Nonequity crowdfunding generally does not involve the sale or offer for sale of a security. Equity crowdfunding, on the other hand, generally results in the sale or offer for sale of an equity or debt interest in a company –i.e., a security as defined under the law, but why does this question matter? As mentioned, non-equity crowdfunding is not regulated by securities laws. Accordingly, non-equity “funders” are not allowed to receive any type of security (as defined by the law). There are no limits on how much money can be asked for or raised. While not subject to securities laws, general contract law and some tort laws apply so be sure to avoid overpromising what you can deliver on.

On Kickstarter: Non-equity crowdfunding

Kickstarter is one of the world’s largest crowdfunding platforms—it’s mission is to ‘help bring creative projects to life.” Since its launch in April of 2009, 12 million people have pledged over $2.6 billion, successfully funding 112, 570 creative projects that involved films, music, stage shows, comics, journalism, video games, and food related projects. It became a Benefit corporation in 2015 to further drive home its mission to positively impact society. Funders of Kickstarter projects are offered tangible rewards and unique experiences in exchange for their pledges/contributions. They may receive book or film or copy of the finished work. A larger pledge to a film, for example, may result in an invitation to the premiere. Kickstarter’s model traces its roots to the subscription model of arts patronage, where artists would go directly to their audiences to fund their work.

Local Kickstarter successes

Oso Technologies used Kickstarter to help fund PlantLink, a system that monitors the water needs of your lawn, garden and houseplants and alerts you when they need to be watered, and even waters them for you. Oso raised $96,690 – 12% of its $75,000 goal. Likewise, Electroninks Incorporated used Kickstarter to help fund Circuit Scribe, a rollerball pen with conductive ink that allows users to draw real, working circuits instantly.  Electroninks raised $674,425 -793& of its $85,000 goal.

IndieGoGo

IndieGoGo is a crowdfunding platform where people desiring to raise money can create fundraising campaigns to tell their story and get the word out. Indie GoGo is used world wide-both to raise money and to contribute to other peoples’ passions. There is no limitation on who can use Indie GoGo as long as one has a valid bank account. People contribute to campaigns for many reasons but generally to be involved in what the campaign is doing or to receive perks from the campaign. The Green Observer Magazine used IndieGoGo to help make it financially sustainable. GOM raised $1,259 – 125% of its $1,000 goal. Likewise, error Records used IndieGoGo to help fund Champaign-Urbana’s only all-ages music venue and record store. ER raised $3,480 – 116% of its $3,000 goal. U of I professor Logan Liu used IndieGoGo to help fund MoboSens, a water pollution sensor for smartphones. Liu raised $5,105 – slightly exceeding his $5,000 goal

Other crowdfunding sites

• Crowdfunder: A crowdfunding platform for businesses, with a growing social network of investors, tech startups, small businesses, and social enterprises (financially sustainable/profitable businesses) .
• Crowdfunder: Offers Crowdfunding from individuals and angel investors, and was a leading participant in the JOBS Act legislation.
• RocketHub: Powers Non-Equity Crowdfunding for a wide variety of social projects.
• Crowdrise: A Non-Equity Crowdfunding site for causes and charities. Crowdrise has attracted a community of do-gooders and funds all kinds of inspiring causes and needs.
• Somolend: A site for lending for small businesses in the U.S., providing debt based investment funding to qualified businesses with existing operations and revenue.
• Appbackr: A niche community for mobile app development
• in: A Venice, CA -based company that is a top name ‘white label’ software provider, giving entrepreneurs the tools to get started and grow.
• Quirky: A place for investors, makers, and tinkerers to collaborate and crowdfund with a community of other like-minded folks. 

Equity crowdfunding Under Title III of the JOBS Act

Title III of the JOBS Act allows crowdfunding to be used by for-profit enterprises through “Regulation Crowdfunding” offers. As a result, small startups that are seeking to raise capital can now turn to the general public and everyday investors for capital. Depending on what the startup chooses to offer, the investor may receive equity (i.e., a “share” of ownership in the business) or debt (i.e., providing a small loan to the business).

Regulations to crowdfunding

There are several regulations to crowdfunding. These include among other things:

• Limits the amount of money a company can raise
• The amount of money and investor can invest
• Requires than an intermediary facilitates the transaction via crowdfunding platform
• Creates a regulatory framework within which the intermediary must operate
• Requires that companies disclose certain information about their offers and updates said information accordingly.

Limitations on offering amounts

• $1,000,000 in securities sold (aggregated) during any given 12 month period
• Includes amounts sold by “controlled” entities or entities in “common control” with issuer
• Includes amount sold by predecessor entities
• Amount is not aggregated with other exempt offerings not in reliance on the Crowdfunding Exemption
• Shares issued in crowdfunding transactions are subject to one-year “restricted” period

Investor limits

There’s a maximum amount of securities that can be sold to each individual investor:

• Class 1: Annual income or net worth are less than $100,000 – amount cannot exceed the greater of $2,000 or 5% of the lesser of the annual income or net worth
• Class 2: Annual income and net worth are both equal to or more than $100,000 – amount cannot exceed 10% of the lesser of the annual income or net worth (not to exceed $100,000)
• Annual income and net worth are calculated under the rules for determining accredited investor status – 33 Act Rule 501

The issuer can rely on the intermediary to ensure that investors do not exceed the allowed offering limits

Intermediary and Crowdfunding Platforms

One of the key investor protections for crowdfunding is the requirement that crowdfunding transactions take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. A funding portal is a new type of SEC registrant created by Regulation Crowdfunding which must be registered with the SEC and become a member of FINRA (the Financial Industry Regulatory Authority). The offerings must be conducted exclusively online through a Crowdfunding Platform operated by the registered broker or the funding portal. FINRA oversees the registration of crowdfunding portals to ensure compliance with federal securities laws and FINRA rules. Funding Portals may not, among other restrictions. Offer investment advice or make recommendations, solicit purchases, sales or offers to buy securities offered or displayed on its website; impose certain restrictions on compensating people for solicitations, and hold, possess, or handle investor funds or securities; rather, it must transfer them to a qualified third-party account to be held until offering qualifications and conditions have been satisfied

Intermediary requirements

Intermediaries, among others, must:

• Provide investors with educational materials
• Take measures to reduce the risk of fraud
• Make available information about the issuer and the offering
• Provide communication channels to permit discussions about offerings on the platform
• Facilitate the offer and sale of crowdfunded securities

Disclosure requirements: Issuer

In its offering documents, among the things, the company must disclose:

• Information about officers and directors as well as owners of 20% or more of the company
• A description of the company’s business and the use of proceeds from the offering.
• The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
• Certain related-party transactions.
• A description of the financial condition of the company.

The company must disclose financial statements that, depending upon the amount offered and sold during a 12-month period:

• Shall be certified to be true and complete by the issuer’s principal executive officer (for target offering amounts of $100,000 or less)
• Shall be reviewed by a public accountant who is independent of the issuer (for target offering amounts more than $100,000 but less than $500,000), or
• Shall be audited (for target offering amounts more than $500,000)

The issuers must amend their offering document to reflect:

• Material changes
• Providing updates on their progress toward reaching the target offering amount
• Issuers must file an annual report with the SEC as well as providing it to investors

Ongoing issuer disclosure requirements

• The issuers must amend their offering document to reflect:
  • material changes
  • providing updates on their progress toward reaching the target offering amount
• Issuers must file an annual report with the SEC as well as providing it to investors

Issuer concerns

• Disclosure requirements
  • Issuer disclosure requirements are many, varied and detailed. They must be disclosed on Form C under Regulation Crowdfunding and filed through EDGAR and made available to investors prior to commencement of the offering.  This information must be made available to investors at least 21 days prior to the sale of the first security
  • Provision of ongoing reports
• Special rules related to advertising
  • All investors must be directed to the intermediary’s crowdfunding portal

Intermediary concerns

• Proper registration with the SEC & FINRA
• Due diligence requirements
• Proper opening of investor accounts
• Proper electronic transmission of issuer disclosure and education information
• A process for qualifying that investors are not exceeding offering limits
• Maintaining open channels of communications for investors
• Receiving investor notice of commitment & cancelation within withdrawal period
• Properly maintaining funds, for the broker-dealer; transferring them to a qualified third party account holder, for the funding portal

Eligibility

• Certain companies may not utilize the crowdfunding exemption including:
  • Non-U.S. companies
  • Companies that already are SEC reporting companies
  • Certain investment companies (such as hedge funds)
  • Companies that are disqualified under the proposed disqualification rules
  • Companies that have failed to comply with the annual reporting requirements in the proposed rules
  • Companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies

State laws

Many states, including Illinois, have their own crowdfunding statutes adding another layer of rules and regulations. The SEC makes the Issuer information available to state regulatory authorities. The JOBS Act does preempt state securities laws concerning registration, documentation and offering requirements for securities issued pursuant to the crowdfunding exemption. The JOBS Act does not limit or impact states’ enforcement actions concerning fraud, deceit or unlawful conduct of an issuer, funding portal or any other person or entity using the exemption. States may impose fees if they are the issuers’ principal place of business or if more than half the purchasers of a crowdfunding offering are in that state. A funding portal’s home state may regulate the portal, but cannot impose rules that are different or additional to what is required under the JOBS Act

Regulation crowdfunding in a nutshell

• Maximum amount allowed to be raised: $1M in 12 month period
• Number of investors: Unlimited, but subject to maximum total raised
• Max investment/investor: Restricted by income/net worth
• Investment disclosure: Required, must be filed with SEC
• Intermediary required: Broker/dealer or funding portal
• Subject to ongoing SEC reporting following raise: At least annually, possible more frequently
• Disclosure liability: Full disclosure liability with a knowledge exception
• Resale of shares restriction: For one year
• State filing requirements: Differs from state to state
• Advertising & General Solicitation: Not allowed; must go through respective crowdfunding portal
• Can public companies, foreign Issuers, Investment companies and exempt investment companies use this exemption: No

Equity in crowdfunding

• Outside “validation” of product
• Capital raising is opened to a broader audience
• Equity Crowdfunding could formalize friends & family investments
• Equity Crowdfunding is a way to fund entrepreneurs outside of tech & life sciences
• Opportunity for accredited investors to diversify portfolio
• Entrepreneur may retain greater control of her company
• Consumer protections – provision requiring companies raising more than $500,000 through crowdfunding to provide audited financial statements