What the New Equity Crowdfunding Rules Mean for Entrepreneurs
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The SEC has finally released rules for Title III of the JOBS Act, the equity crowdfunding law. Nearly three years and seven months after the potentially game-changing bill was first signed into law, equity crowdfunding will be available to startups and small companies in 180 days. Yes, we get to wait another half a year before anyone can actually use equity crowdfunding, but at least now we know it will happen.
For those who have run out of Ambien, the hundreds of pages of new rules will provide a welcome sleep aid. But for professionals who plan to use these rules to help companies raise new capital, it is required reading. Bring on the Red Bull.
What does this mean for entrepreneurs? Will startups be able to actually use this law? Let’s take a look at what the new SEC rules say about key provisions, to answer those questions:
1. The JOBS Act says a company can raise up to $1,000,000 with Title III equity crowdfunding. Did the SEC expand this?
Despite the hopes of many of us that the SEC would pull a regulatory rabbit out of a hat and raise the ceiling to $5 million, the limit on what a company can raise through Title III equity crowdfunding remains at $1 million. If a company wants to raise more, there is always equity crowdfunding’s prettier cousin, a Regulation A+ mini-IPO to consider.
2. What can members of the “crowd” invest?
The law limits investors to (a) the greater of $2,000 or 5 percent of the lesser of their annual income or net worth, if either the annual income or the net worth of the investor is less than $100,000 and (b) 10 percent of the lesser of their annual income or net worth, if both the annual income and net worth of the investor is equal to or more than $100,000.
In both cases, Investors may not invest more than an aggregate amount of $100,000 in one year. The SEC actually tightened up the amounts that can be invested by each individual, which is not good news for entrepreneurs.
3. What happens if a company does not raise its goal amount?
Like many rewards-based crowdfunding campaigns and Regulation A+ mini-IPOs, if a company using the new equity crowdfunding law does not raise the full amount of their funding goal, they do not get to keep any of the money raised, and they lose the out-of-pocket up-front costs. This important provision means setting a realistic goal will become an important part of the equity crowdfunding process for entrepreneurs.
4. Can companies afford to use Title III equity crowdfunding?
The biggest news from the new SEC rules is that the proposed requirement of a full financial audit has been dropped by the SEC for companies using the equity crowdfunding law for the first time. Requiring a startup to spend tens of thousands of dollars on an audit made no sense. The SEC removed that burden, and now a company using the law for the first time must only have reviewed financials to raise more than $100,000, and lesser financial disclosures when raising less than $100,000.
There are still substantial costs, however. Legal fees, compliance costs, funding portal fees, broker-dealer fees and marketing expenses can add up. Without entrepreneurial minded attorneys offering affordable services and innovative businesses offering compliance services for a reasonable cost, equity crowdfunding would still be out of reach for most young companies. Luckily for startups and small businesses, both of the above exist, and will make this law affordable to use for most entrepreneurs.
5. What information has to be disclosed?
A company has to disclose to investors, and file with the SEC, the price of the securities, the method for determining the price, the target offering amount, the deadline to reach the target and whether the company will accept investments in excess of the target.
Companies also must provide a discussion of the company’s financial condition, a description of the business and the use of proceeds from the offering, information about officers and directors and owners of 20 percent or more of the company and annual financial statements.
6. What liability will a company and its officers have under equity crowdfunding?
Equity crowdfunding involves the sale of securities, and not just pre-selling a gadget like on Kickstarter. There are federal and state laws that govern the sale of securities, and if you do something wrong, your company (and its officers and directors) can be sued, and in some cases, could go to jail.
The bottom line is simple: Tell the truth. Under most securities laws including the equity crowdfunding law, being 100 percent truthful and not making misrepresentations of any kind are the keys to not having to bang out license plates in the prison yard with Bernie Madoff.
7. Are the shares sold through equity-crowdfunding liquid?
No. Much like most shares sold through private placements, the shares of stock sold in equity crowdfunding cannot be sold (in most circumstances) for at least one year. There is no marketplace or exchange for these shares, and in all likelihood, never will be unless a company registers with the SEC and becomes a public company.
Will equity crowdfunding work under the new SEC rules? Some may disagree, but I believe there is a workable model here that startups will be able to use to raise capital.
Like every new law, how usable it will be depends on a number of factors. But the reality is that an opportunity like this for startups to raise capital has never existed before, and rather than criticize the law's shortcomings, some of us will work within the laws and rules to find ways to help companies raise funds online in a way they never could before.