Securities Advisory Releases
Advisory Release AR-12-02:
Passage of the CROWDFUND Act of 2012: Next Steps
The Commissioner of Securities is issuing this advisory release to alert Missouri’s entrepreneurs to recent Federal legislation that will impact their ability to raise capital for their small businesses. As explained below, the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (the “CROWDFUND Act”) allows entrepreneurs to use crowdfunding over the Internet to finance their ventures. The legislation has specific limitations on how the offering may be conducted and to whom small businesses can sell their securities. Moreover, although this legislation was recently signed into law, it is not yet implemented through administrative rulemaking and the exemptions it contemplates will not be available for several months. Issuers and entrepreneurs are cautioned against jumping the gun in attempting to use this exemption.
The CROWDFUND Act of 2012
As discussed in a previous advisory release, crowdfunding is an online money-raising strategy that allows the public to use websites to financially contribute to the projects of artists, musicians, filmmakers and others. Recently, crowdfunding financing has been applied to small businesses and start-ups, facilitating their attempts to get their ventures off the ground.
On April 5, 2012, President Barack Obama signed into law the Jumpstart Our Business Startups Act, a series of legislative reforms intended to facilitate capital formation in the United States. Part of this legislation included the CROWDFUND Act.
The CROWDFUND Act makes significant changes in current Federal and state securities laws. The CROWDFUND Act will allow entrepreneurs to raise capital by offering to sell interests in their businesses over the Internet. The CROWDFUND Act will allow a small business to raise $1 million in a 12-month period by selling its securities to investors without registering that offering with the Federal or state securities regulators. However, the act places limitations on how and to whom the small business can sell its securities.
For instance, how much a crowdfund-financed small business can sell to an individual investor depends on the investor’s income or net worth. Specifically, if the investor’s annual income or net worth is less than $100,000, then the small business can only sell securities to the investor in an amount not exceeding the greater of $2,000 or 5% of the investor’s annual income or net worth. If the investor’s annual income or net worth is greater than $100,000, then the amount may not exceed 10% of the investor’s annual income or net worth or an aggregate amount of $100,000.
Additionally, a business using the crowdfunding exemption must offer its securities through a broker or a “funding portal.” These funding portals must meet the qualifications established by the Securities and Exchange Commission (“SEC”) in subsequent rulemaking. Both the broker and the funding portal must register with the SEC.
Finally, the CROWDFUND Act also requires the broker or funding portal and the small business to make certain disclosures to the SEC and potential investors. The subject matter of these disclosures will be further established by SEC regulation.
The CROWDFUND Act directs the SEC to promulgate rules implementing the crowdfunding exemption within 270 days after the date of enactment. While the SEC recently announced it was seeking public comment prior to its rulemaking efforts, it is still quite possible that the rules necessary for actual use of the exemption may not be in place until 2013.
The CROWDFUND Act is a significant development for small businesses. However, along with this opportunity comes certain concerns, some of which the Commissioner highlights below:
- Don’t jump the gun. Do not start using any Internet resources to raise capital for your business under the crowdfunding exemption until it becomes law. As noted above, the SEC must still promulgate rules implementing the exemption. Consequently, a small business cannot offer its securities in reliance on the crowdfunding exemption until the Federal rulemaking is complete, which won’t be for several months. Until that time, Federal and state securities law prohibitions remain in place against publically-accessible Internet securities offerings.
- The crowdfunding exemption does not change the securities laws’ disclosure requirements. The crowdfunding exemption is only an exemption from the securities laws’ registration requirement. However, the Federal and state securities laws’ other requirements regarding disclosure to investors remains in place. If you do not comply with those requirements, you and your business can be liable for securities fraud, and subject to private lawsuits as well as administrative enforcement.
- Consider hiring an attorney. The crowdfunding exemption is meant to lower your capital-raising costs by exempting your $1 million or less capital formation efforts from registration. But, a small business using this exemption still needs legal guidance as to how to comply with the CROWDFUND Act’s requirements as well as the general Federal and state securities laws. During the time until you can use the crowdfunding exemption, consider speaking with an experienced securities law attorney to help you in your offering.
- Be careful in choosing the broker or funding portal. Be aware of unscrupulous persons offering to take fees from you now to help you raise capital over the Internet. Because the CROWDFUND Act is not implemented yet, such offers could be a scam, preying upon those entrepreneurs less familiar with the act’s requirements. Or, this premature offer could indicate that the offeror is unfamiliar with the intricacies of the new laws and is perhaps less sophisticated than would be desired.
Also, understand that, if your broker or funding portal does not comply with the SEC’s rules on the CROWDFUND Act, your exemption may be voided, subjecting you to liability for an unregistered offering. Thus, when you do select one, be sure that the broker or funding portal thoroughly complies with the requirements of the CROWDFUND Act and its rules. It is your business, after all, so ask questions to ensure that the broker or funding portal is thoroughly familiar with the act and is motivated to see your business properly and legally get off the ground.
For more information on offering securities and raising capital in Missouri, contact the Missouri Securities Division’s Registration Section at (573) 751-4136.
April 20, 2012