The JOBS Act
The term “crowdfunding” refers to several very different types of funding: donation, pre-purchase, rewards, and investment. Donor crowdfunding is the solicitation for gifts or donations for personal or charitable causes. Pre-purchase crowdfunding is the solicitation for pre-production donations or advance purchases in exchange for the produced product or a prototype of the product. Rewards crowdfunding is the solicitation for contributions to a project, such as a film production where the donors are promised public recognition or a small role in the film. In contrast, investment or equity crowdfunding involves the offer of a share in any financial returns or profits that the fundraiser may expect to generate from business activities financed through crowdfunding.
Title III of the JOBS Act, popularly known by its short title, the “CROWDFUND Act (Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012),” creates a new exemption for investment or equity crowdfunding. (In this blog, we will just call it the Act.) Specifically, the Act exempts crowdfunded securities from the federal registration requirement for up to $1 million during a 12-month period (with different thresholds for amounts sold to individual investors, depending on the annual income or net worth of such investors) when the transaction is conducted through an intermediary that is either a broker or a funding portal. A company that wants to use this exemption would have to meet certain conditions. For example, the company would have to provide the SEC, its broker or funding portal, and potential investors with certain basic information about the company, its business plan, a description of its financial condition and ownership structure, and the target offering amount and how it intends to use the proceeds, among other things. The level of financial disclosure required would vary, depending on the offering amount, and could involve audited financial statements for offerings of more than $500,000. The company would also have to provide the SEC and investors with annual financial reports. Importantly, in terms of advertising, the company would be limited to directing investors to the broker or funding portal to obtain information about the offering.
The Act, in turn, imposes various requirements on intermediaries. For example, they would need to register with the SEC and become a member of a national securities association. They would have to provide risk disclosures or other investor education materials and ensure that each investor reviews such information and understands the risks. They would also need to take measures to reduce the risk of fraud by obtaining a background check on certain key persons of every issuer and providing such information to potential investors. A funding portal cannot: (i) offer investment advice; (ii) solicit purchases, sales, or offers to buy securities offered on its website or portal; (iii) compensate employees and others for such solicitation or sale; or (iv) handle investor funds or securities, among other things.
We say “would,” because, almost three years after the passage of the Act with overwhelming bipartisan support, crowdfunding remains illegal at the national level (though some states allow intrastate crowdfunding under state law, which we will discuss more later). This is so because the SEC has not finalized rules to implement the crowdfunding provisions of the JOBS Act. The SEC has issued proposed rules, which give us some idea of how the exemption would work. In our next post, we will look at some of the provisions of the proposed rules and how they might affect businesses.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
About the Author
So-Eun Lee – So-Eun Lee is an associate attorney in the New York office of The R. Shawn McBride Law Office, P.L.L.C. She concentrates her practice on business law. So-Eun can be contacted at: (347) 921-0173 or email@example.com. Her profile is available on www.mcbrideattorneys.com.
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: (214) 418-0258; firstname.lastname@example.org, or www.mcbrideattorneys.com.
 Russell C. Weigel, III, Capital for Keeps: Limit Litigation Risk While Raising Capital, at 14-15.
 78 Fed. Reg. 66,427, 66,429 (Nov. 5, 2013) (internal citations omitted).
 See generally Jumpstart Our Business Startups Act, Title III.
 15 U.S.C. § 77d(a)(6).
 Id. § 77d-1(b).
 See generally id. § 77d-1(a).
 Id. § 78c(a).
 See generally 78 Fed. Reg. 66,427 (Nov. 5, 2013).