Crowdfunding began more than a decade ago, when artists, musicians, filmmakers, and politicians raised online donations from their supporters through a website or other Internet-based portal. Small businesses then entered the fray by seeking interest-free loans or donations through the Internet. However, U.S. federal securities laws prohibit companies from using this method to sell their stock or other securities. On April 5, 2012, after passage through both chambers of Congress with much fanfare and controversy, President Obama signed the Jumpstart Our Business Startups Act (JOBS Act) into law, which includes, among other things, certain provisions providing for a crowdfunding exemption to the Securities Act of 1933 for certain businesses.
This new exemption will permit certain businesses, including those in the cleantech industry, to raise up to $1 million from equity investments within any 12-month period from accredited or non-accredited investors without triggering the registration requirements of the Securities Act of 1933, so long as the offering is conducted through an SEC-approved crowdfunding broker or Internet-based funding portal. Refer to Title III of the JOBS Act for more information on its crowdfunding provisions.
Proponents have hyped the JOBS Act’s crowdfunding provisions as providing small businesses with greater access to much needed capital in a trying economy, and believe the provisions will fill the gap between seed and institutional/venture capital rounds of financing, and will provide small businesses with the opportunity to grow and put more Americans who have lost their jobs back to work. Critics predict that the act will not create jobs, will strip investors of protections essential to capital raising, and is nothing more than political posturing by Congress and the President in an election year.
The SEC has 270 days from the enactment of the JOBS Act to amend its rules and regulations to implement these crowdfunding provisions. Until then, businesses may not consummate any crowdfunding offering of its securities.
Many clients of Hodgson Russ who run businesses in a variety of industries have contacted the firm with great excitement and interest in using the Internet to offer and sell stock and other securities once the crowdfunding provisions of the JOBS Act are implemented by the SEC. Of course, my opinion is subject to what the SEC’s final rules and regulations will require, but for the following reasons, I would advise such companies to be wary of this new method of capital raising:
- The crowdfunding provisions of the JOBS Act are extremely complex and create SEC filing obligations that will undoubtedly create added costs (legal, accounting, etc.) and potential liability for issuers and brokers/Internet portals, with the benefit of obtaining only up to $1 million in financing over a 12-month period.
- There is a possibility that venture capitalists or other institutional investors may shy away from issuers that have previously engaged in one or more crowdfunded offerings due to the potential liability and uncertainty of such offerings.
- The unnecessarily complex crowdfunding provisions stand in stark contrast to the relaxed public solicitation/advertising rules that will be permitted for Rule 506 offerings to accredited investors once the JOBS Act is implemented—just do a Rule 506 offering instead!
For further information on crowdfunding, please see these slides from an internal presentation that I delivered to my Hodgson Russ colleagues in mid-May.