By Christina Morales, CrowdFunding News Wire,
It seems like new buzzwords pop up all the time and the one that I am hearing a lot about lately is “crowdfunding.” I know it’s been around for several years, but it seems to be picking up speed and becoming a readily accepted method of fundraising for both nonprofit and entrepreneurial ventures. As this new virtual tool continues to gain popularity, laws have been passed to regulate these financial exchanges. If you are crowdfunding or are just curious about garnering additional funds for your small business, there are a few guidelines that you should be aware of.
Let’s get some of the basics out of the way first. If you’re not familiar with crowdfunding, Chance Barnett of Forbes provides a great explanation: “There are 2 main models or types of crowdfunding. The first is what’s called donation-based funding. The birth of crowdfunding has come through this model, where funders donate via a collaborative goal based process in return for products, perks or rewards.
“The second and more recent model is investment crowdfunding, where businesses seeking capital sell ownership stakes online in the form of equity or debt. In this model, individuals who fund become owners or shareholders and have a potential for financial return, unlike in the donation model.”
How Does this Apply to Small Businesses?
For all intents and purposes, we’re going to be talking about the second model as applied to small businesses. Entrepreneurs have been harnessing the power of crowdfunding sites (such as Kickstarter, AngelList, Crowdtilt, Fundable, Quirky, and Indiegogo) for the past several years with continued growth. For example, in 2012 the amount of funds raised through these and similar platforms was $2.7 billion. When you break it down, 52% or approximately $1.4 billion has been raised through donation/rewards-based platforms, 44% was raised through lending-based platforms, and the remaining 4% came from equity-based platforms. In 2013 it was projected that there would be a growth of 89% on these sites which equates to a total value of $5.1 billion.
With so much money on the line, the Jumpstart Our Business Startups (JOBS) Act was signed into law by President Barack Obama back in April 2012. The Act requires the SEC to write rules and issue studies on capital formation, disclosure, and registration requirements which includes data pertaining to funds raised through crowdfunding by selling securities.
However, the team at RocketHub felt that the federal regulators’ strict audit requirements for crowdfunding companies would impose a heavy financial burden on small businesses. The new requirements that allowed for the selling of stock could create potential investor lawsuits, therefore requiring those companies to purchase expensive liability insurance plans. The question posed is whether the finances raised through crowdsourcing will outweigh the cost of insurance and lawsuit bills.
This past June, the Crowdfunding and Securities Exemption Act (CASE) was passed in Wisconsin. “For businesses and investors who utilize the crowdfunding exemptions, the law allows an unlimited number of non-accredited investors to invest up to $10,000 per equity offering. Accredited investors and a newly created designation of ‘certified’ investors still will be able to invest without limit. Businesses offering on the platform are able to raise a maximum of $1 million with unaudited financial statements, and $2 million if they undergo an audit and disclose the results to potential investors,” comments Dave Craig and Leah Vukmir in the Journal Sentinel.
Now keep in mind that the JOBS Act was passed back in 2012. At that time, it gave the SEC until the end of that year to issue rules allowing entrepreneurs to start raising small amounts of capital from mom-and-pop investors through new online crowdfunding sites. Now two years later there is a proposal in place, but still nothing set in stone. For the SEC, the hold-up in drafting the specific rules has been finding the right balance between protecting non-accredited (often less wealthy and less seasoned) investors from shady offerings, while still breaking away barriers to capital for entrepreneurs.
“These rules arise from laws passed two and a half years ago, and Congress is looking to us to get them done,” SEC Commissioner Kara M. Stein said during an event on small business capital formation on Thursday. “Quite frankly, I don’t think we’re very far away on some of these rules. Let’s get them done.”
Regardless of the stalemate in Washington, crowdfunding can be a profitable opportunity for investors and entrepreneurs alike. Nevertheless, it is best that you contact acorporate lawyer to find out the specific laws that apply in your state. Procuring international or out-of-state financiers, selling securities, and distributing rewards can cause a tangled mess of regulations and federal law best left to the professionals to make sense of.