Crowdfunding: A New Opportunity to Raise Business Capital
In April, a new method of raising capital for start-ups was created, and cast under the regulatory authority of the SEC, by the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act, also known as the CROWDFUND Act. The term "crowdfunding" broadly refers to the concept of raising a pool of funding from small investments by a large number of investors.
Born from that concept, the CROWDFUND Act allows up to $1 million in capital to be raised through an intermediary, including a broker or a "funding portal," from non-accredited investors in an offering that is exempt from the requirements of preparing a prospectus and filing a registration statement with the Securities and Exchange Commission ("SEC").
Nevertheless, the Act includes its own requirements and restrictions. For example, the so-called "funding portals" – essentially online investment websites – must be registered with, and comply with the rules and restrictions of, the SEC. Additionally, an issuer seeking to use the CROWDFUND exemption must verify that each investor demonstrates "an understanding of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers" as well as certain, specific other requirements.
Issuers are required to comply with a number of disclosure provisions under the Act, and certain portions of these disclosure requirements increase as the amount of capital the issuer seeks to raise increases. An issuer seeking to raise $100,000 or less must disclose, in addition to other required disclosures, its income tax returns for the most recently completed year and financial statements certified by the principal executive officer of the issuer. An issuer seeking to raise more than $100,000 but less than $500,000 must disclose financial statements reviewed by an independent public accountant. Issuers seeking to raise more than $500,000 must disclose audited financial statements.
Additionally, while investors may be non-accredited, there are still certain restrictions on who may invest and how much may be invested. The aggregate amount sold to any one investor, for example, may not exceed the greater of $2,000 or 5% of his/her annual income if the net worth of the investor is less than $100,000. An investor with a net worth of $100,000 or more may purchase up to 10% of his/her annual income or net worth, as applicable, not to exceed a maximum aggregate purchase of $100,000.
While an offering made in compliance with the CROWDFUND Act is not required to provide a prospectus or register with the SEC, the issuer is required to file certain information with the SEC, including without limitation a description of the business and the financial condition of the issuer, as well as the stated purpose and intended use of the proceeds of the offering.
Issuers may not advertise the terms of the offering except for notices to direct potential investors to the broker or funding portal. Additionally, issuers may not compensate, directly or indirectly, any person to promote the offering through the broker or funding portals without disclosing such compensation under SEC rules.
The Act provides for a private right of action by purchasers in a covered offering against issuers for material misstatements and omissions in connection with the offering. This liability extends to the directors or partners of the issuer, as well as the chief executive officer and chief financial and accounting officers of the issuer.
Finally, the CROWDFUND Act directs the SEC to prepare rules and regulations, as necessary and appropriate, in order to carry out the provisions of the Act. Until such rules and regulations have been implemented, the SEC warns that any offer or sale of securities that purports to rely on the CROWDFUND exemption is unlawful under federal securities laws. The SEC is currently soliciting public comments on these regulatory initiatives, and final rules may be issued later this year.
Thus, the CROWDFUND Act has created a new exemption to the prospectus and SEC registration requirements for securities offerings to allow crowdfunding of startup and small businesses with certain disclosure and compliance requirements. Once the SEC has promulgated its rules and regulations, this exemption will be a new opportunity to raise a pool of capital from small investments by a number of non-accredited investors. Care must be used in following the CROWDFUND Act and other SEC requirements as failure to do so may result in litigation and personal liability.