This is the first in a series of two articles on crowdfunding. Be sure to check back next month for the second installment.
Investing in new business ventures has traditionally been by private invitation only for accredited and wealthy investors. Until recent years, a typical example of “crowdfunding” might have amounted to taking up a collection to help your neighbor pay for his new pool. Thanks to the Jumpstart Our Business Startup Act of 2012 (JOBS Act), new businesses can now legally seek equity crowdfunding without running afoul of securities regulations, and virtually anyone with extra cash can be a potential investor.
Equity crowdfunding allows a private company to use the Internet to offer equity to individuals or groups in exchange for money. An owner of equity is entitled to a share of the company’s future profits; equity usually takes the form of stock or units, and in legal terms is referred to as a “security.”
The JOBS Act legalized online crowdfunding through the offering and sale of certain types of securities to a wide range of investors. The act also authorized and required the Securities and Exchange Commission (SEC) to come up with regulations to implement the new law. The SEC has completed this process and at the federal level there are now a variety of forms of crowdfunding from which one may choose. Here are some of the highlights of a few of them:
Rule 506(c)
Under Rule 506(c), a company may offer securities over the Internet to an unlimited number of accredited investors. Examples of accredited investors include (a) individuals with an annual income of at least $200,000, or couples with an annual income of at least $300,000; or (b) a person with a net worth exceeding $1 million, either individually or jointly with his or her spouse. Being able to advertise the offering has benefits for both the company and investors, however, under 506(c) the company bears the burden of verifying investors’ accredited status. 506(c) offerings require the filing of Form D with the SEC.
Regulation A+
Offerings under Regulation A+ are divided into “Tier 1” and “Tier 2”. The Tiers are designed to be mutually attractive for different reasons and for different new companies and investors. Under Tier 1, a new company can offer up to $20 million per 12 months with no caps on the amount individuals can invest. Tier 2 offerings can be up to $50 million per 12 months, but for non-accredited investors are subject to individual investment caps equal the greater of 10% of either the investor’s income or net worth.
Both Tiers allow offerings to all types of investors and can be advertised as there is no restriction on general solicitation. The rules also allow for pre-disclosure “testing the waters” to determine if there is interest in the offering before investing time and money in an initial Offering Statement. Both can be offered via the Internet, including through a portal or intermediary. Both Tiers have certain federal and state filing requirements.
Regulation Crowdfunding (Regulation CF)
Regulation CF allows a company to offer up to $1 million in securities per 12 month period. Anyone can invest, however there are restrictions on the amount that can be invested by any one investor based on the investor’s income or net worth. Securities offered through Regulation CF must also be sold through an intermediary that is either a registered broker-dealer or a registered entity “funding portal”. Importantly, Regulation CF offerings must be made over the Internet. There are disclosure and ongoing reporting requirements.
Next month, we will discuss North Carolina’s crowdfunding law that recently went into effect and how it differs from the federal JOBS Act rules.
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