Mar 1

Should You Crowdfund Your Business?

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Bunch of different sized piggy banks

For new or would-be entrepreneurs, the central priority is often raising cash. Even when the start-up costs associated with the invention or development of the business idea are low, there is a need for outside capital to market the business to the public. Where can a new business find this funding? In recent years, there has been a push to allow companies to obtain this funding more directly from the public, taking down some of the usual barriers to the public stock markets for early-stage businesses. This concept has coined “crowdfunding” – a process by which the general public (or crowd) funds a new business idea, primarily via an online portal.

What about the stock market?

The U.S. stock market is one of the best sources of significant capital to run a business. But it has a high entry barrier. Companies must meet stringent disclosure and audit requirements before they can be listed on the major, public exchanges. The costs associated with the audit and making the necessary disclosures have increased as regulations have increased in the financial marketplace.

The federal securities laws require that companies file detailed registration statements before offering shares of their stock to the public. There are certain exemptions that exist that allow a company to sell shares without filing a registration statement. The JOBS Act of 2012, signed into law on April 5, 2012, created a new exemption (known as the Crowdfund Exemption) that aims to significantly lower the barrier to public funding by eliminating the registration requirement before certain securities are sold to investors, even investors who cannot show a high income or high net worth.

The Crowdfund exemption from registration

To take advantage of the Crowdfund exemption, the aggregate amount of securities sold to all investors may not be more than $1 million and the aggregate amount sold to any one investor may not be greater than either (1) $2,000 or 5% of the investor’s annual income or net worth if the annual income or net worth of the investor is less than $100,000 or (2) 10% of the annual income or net worth of the investor, not to exceed $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000. Further, the transaction must be conducted through a broker or funding portal that meets certain new registration and disclosure requirements.

When will crowdfunding begin?

The SEC was required to issue regulations to carry out the Crowdfund exemption within 270 days of April 5, 2012. But the SEC has not met this deadline and has not stated when it expects to issue the necessary regulations. Others have speculated that the SEC will issue the regulations in January 2014. 

Be wary of sites promising you the ability to raise money for your business

Until then, be wary of websites that claim you can easily raise money for your business. And be wary of sending your money to companies seeking to crowdfund. Government entities are taking steps to crack down on companies that are jumping ahead of the regulations but it is impossible for them to keep up with the proliferation of the various crowdfunding websites.

If you use a site that is claiming to crowdfund and it doesn’t meet the SEC requirements for the Crowdfund exemption (which it cannot possibly do right now because the requirements are not yet known), you may inadvertently violate the federal securities laws. There are many other options for raising capital, including angel investing, private equity, and other means that access the capital of accredited (i.e. high net worth) investors.

The bottom line is if you are interested in raising money for your business, you should consult an attorney to make sure you do not inadvertently violate any securities laws.