Equity crowdfunding is a financing option that allows companies to raise up to $1 million online. The Jumpstart Our Business Startups (JOBS) Act directed the SEC to change its rules to make this happen so that small businesses would not have to follow complicated and expensive registration rules for raising money from the public.
Now the SEC has proposed rules for using this option; after a comments period, the rules likely will be finalized in February 2014. Here are some highlights:
- The $1 million cap applies for a 12-month period. Thus, equity crowdfunding isn’t a one-shot deal; in effect it can be used annually as needed.
- Equity crowdfunding can only be done through an approved (registered) portal or a registered broker-dealer. So a company can’t raise the funds on its own. The portal or broker-dealer cannot offer advice or compensate employees for equity crowdfunding sales. Likely, because of the compensation rule, online portals will be the main venue for this funding option.
- Investors have a cap on what they can invest through crowdfunding: 10% of annual income or net worth for those with incomes of $100,000 or more; 5% of annual income or net worth or $2,000, whichever is greater, for those with incomes of less than $100,000.
- Companies using crowdfunding must make certain financial disclosures. For example, when raising more than $500,000, audited financial statements must be submitted to the SEC at least 21 days before the first sale. Those raising less money are not required to submit audited financial statements, but have other financial disclosure burdens. All companies that use equity crowdfunding must file certain disclosure at the start (e.g., information about officers and directors as well as owners of 20% or more of the company) and report to the SEC when their funding round has been completed.
- Companies cannot advertise or solicit money other than through an approved online portal.
A word to companies seeking financing
Don’t rush to use equity crowdfunding because all of the benefits and burdens are not yet clear. What are your obligations to crowdfunding investors? What will the real costs be to the company for this funding mechanism? What will the dilution of business interests because of equity sharing with crowdfunding investors mean to you?
While equity crowdfunding may be on hold for many companies, remember that traditional (nonequity) crowdfunding can still be used to raise small sums from a large pool of investors. This avenue solicits contributions; donors usually aren’t given anything for their contributions other than the satisfaction of helping a project or business succeed.
A word to potential investors
If you’re thinking about supporting new businesses seeking capital through equity crowdfunding, pause. The projects may be worthy, but your position isn’t clear:
- What information about the company will you be privy to?
- How will you be able to determine whether your investment has made or lost money?
- How can you dispose of your holding if you want to?
Equity crowdfunding looks great on paper and may turn out to be a good financial solution for many startups and small businesses looking to expand. It’s just too early to tell. My advice: Wait for SEC rules to be finalized. Let other companies be equity crowdfunding guinea pigs and learn from their mistakes. In the meantime, continue to stay abreast of equity crowdfunding developments through the SBE Council.