Raising equity through crowdfunding

The Jumpstart Our Business Startups, or JOBS Act, signed into law April 5 by President Obama provides a significant change to the way small businesses are able to access equity funding. A key provision allows small businesses to raise a limited amount of equity financing through crowdfunding.The “crowd” in “crowdfunding” generally refers to groups of investors who pool their money together to support a new grassroots endeavor or to accomplish a specific goal, such as the development of a new software application or to provide micro lending.In many ways, crowdfunding is the next generation of the traditional “friends and family” investor group. While contributions from individual investors are generally smaller than in angel financing, the crowd is often more strongly motivated to support the startup owner and his business idea over the investors’ own return on investment. As such, the crowd stands apart from traditional financiers as its investment decisions are strongly influenced by the group’s very personal likes, dislikes, needs and wants in seeing a new product or service enter the marketplace.Once the regulatory framework is in place, crowdfunding transactions will occur over the Internet through an intermediary. Any person acting as an intermediary in a crowdfunding transaction will need to register with the U.S. Securities Exchange Commission, either as a broker-dealer or as a “funding portal” – a new form of entity created under federal securities laws. The intermediary will be responsible for making sure that information about the company and securities being offered are made available to investors, affirming that investors understand that there is a risk of loss with the investment being made, and taking steps to reduce the risk of fraud.The goal of the intermediary will be to provide absolute transparency about the company, the potential investment and the risks associated therewith.Along the same lines of transparency, companies offering securities under the crowdfunding exemption will need to provide some basic information about the company to the SEC, the intermediary and potential investors, including the name, legal status and business address of the company, the names of directors, officers and shareholders holding more than a 20 percent equity stake, a description of the business plan, a description of the financial condition — including income tax returns (if any) and financial statements — a description of the ownership structure and a description of the offering details (including the target offering amount and the deadline to reach the offering amount).Companies in need of funding to develop proprietary technology will need to be careful about securing intellectual property rights and/or limiting disclosure of proprietary information in investment disclosures prior to posting such information on a funding portal as this information will be made available to the public.Investment limitationsInvestors in a crowdfunding transaction will be required to hold their stock for at least one year and may not transfer their stock unless it is being transferred back to the company, an accredited investor, an immediate family member or pursuant to a public offering.The total dollar amount that can be raised by a company under the crowdfunding exemption over a 12-month period is $1 million, or $2 million if the company provides potential investors with audited financial statements. The amount of stock that any particular investor can purchase over a 12-month period is likewise capped.For investors with an annual income of $100,000 or more, the amount sold to any investor by a company cannot exceed the lesser of $10,000 or 10 percent of the investor’s annual income. For investors with an annual income of less than $100,000, the amount sold to any investor by a company cannot exceed the lesser of $2,000 or 5 percent of the investor’s annual income.Under other securities exemptions, investment in privately held businesses is limited to the richest 2 percent of Americans. By contrast, a much broader range of investors will be able to participate in crowdfunding and influence the types of businesses and technologies that are developed.The SEC has until Jan. 1, 2013, to implement rules under the new law. Language contained in the JOBS Act gives the SEC broad authority to implement any requirements as it sees fit for the protection of investors and the public interest. Indeed, there is already much speculation about a rise in securities fraud under the crowdfunding exemption, and no doubt the SEC will draft the new rules with fraud prevention chiefly in mind.Taking the time to understand the new regulatory framework and seeking advice from securities counsel before jumping into a crowdfunding offering, as either a company raising funds or an investor, is well advised.Paul C. Remus is a shareholder at Devine Millimet & Branch, Manchester, representing both companies and venture capitalists in private placements and other financings. Kristin A. Mendoza, an associate at Devine Millimet, is experienced in counseling startup businesses. They can be reached at 603-699-1000.