In May of this year, the rules adopted by the Securities and Exchange Commission (SEC) regulating equity-based crowdfunding finally became effective. Crowdfunding is the process of raising small amounts of money from a large number of individuals. There are two main types of crowdfunding that currently exist in the market: (i) reward-based and (ii) equity-based. Reward-based crowdfunding involves raising money from contributors in exchange for some type of prize or reward. Reward-based campaigns often involve the pre-sale of products (i.e. a filmmaker pre-selling a DVD or digital copy of a film he or she has yet to produce, or a company pre-selling a product it has yet to manufacture). Popular platforms for reward-based crowdfunding include Kickstarter and Indiegogo.
Prior to the passing of the JOBS Act of 2012 and the corresponding adoption of the recent equity-based crowdfunding rules by the SEC (called Regulation Crowdfunding), reward-based crowdfunding was basically the only legal form of crowdfunding that could be utilized by individuals seeking money from the crowd. Entrepreneurs and business owners that wanted to offer equity in their business ventures to the masses in exchange for a small capital infusion were largely prohibited from doing so because of antiquated securities laws. However, with the adoption of the JOBS Act and the SEC’s latest rules, which became effective this past May, entrepreneurs can receive equity capital from the crowd (i.e. general investing public).
Exciting, right? Well, maybe…
The reality is that the JOBS Act and the recent rules that the SEC adopted related to that Act place a lot of restrictions on equity-based crowdfunding. Unfortunately, these restrictions make equity-based crowdfunding out-of-reach for many entrepreneurs and startups because of the high cost of compliance. Here are just a few examples of the restrictions placed on equity-based crowdfunding issuers:
- Filing Form C – Although an issuer does not need to go through the hassle of fully registering the securities they are offering to crowdfunding investors, they do need to file Form C with the SEC in which a number of disclosures are provided.
- Financial Statements – Depending on the size of the offering, the issuer will need to provide federal income tax returns and financial statements. For offerings more than $100,000, the financial statements need to be reviewed, and in certain situations for offerings over $500,000, the financial statements need to be audited.
- Must Use Approved Platforms – Issuers engaging in a crowdfunding offering must use a crowdfunding platform (called a portal) that is registered with the SEC.
- Advertising Limitations – Issuers are very limited in what they can actually say to the general public about the crowdfunding offering outside of the information disclosed on the crowdfunding platform. That’s right, an issuer that is conducting a crowdfunding campaign can really only advertise that it is conducting an offering and direct viewers of the advertisement to the portal that is hosting the campaign.
- Annual Updates – Issuers must file annual updates with the SEC following the completion of a crowdfunding campaign. Only in limited circumstances will an issuer be able to avoid this requirement.
These are just a few of the restrictions that issuers must comply with under the SEC’s new rules. Given the depth and complexity of these restrictions, issuers will need the assistance of professional advisors to ensure strict compliance. While crowdfunding portals will certainly assist in this process to the extent they are able, the reality is equity-based crowdfunding will simply not be an option for startups and entrepreneurs that have limited seed capital because of the heavy cost of compliance.
Notwithstanding the cost of compliance, there are many businesses and entrepreneurs that will be able to benefit from this new way to access capital. Since the Regulation Crowdfunding rules became effective in May, a number of crowdfunding portals have successfully launched equity campaigns for numerous issuers. To see some examples of businesses that are taking advantages of this new source of capital check out WeFunder.com or Fundable.com. If you are interested in launching an equity-based crowdfunding campaign and need assistance preparing and managing your campaign to ensure compliance with SEC rules, please be sure to reach out to Smith Haughey Rice & Roegge for assistance.