Until recently, contributing to a crowdfunding campaign came with mostly trivial perks. New rules proposed by SEC, however, have the potential to reward backers with a perk that was previously only available to accredited investors: equity. By opening up the opportunity to invest for shares to most Americans over the age of 18, the landscape of funding options becomes increasingly varied. It’s an exciting proposal, to be sure, but one laced with legal minutiae that can be difficult to make sense of without counsel.
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Wading through those details was the subject of a talk given by Matt Brown and Mark Wood (pictured at right), both Partners at local law firm Katten Muchin Rosenman, at Startup Sessions, a day-long conference hosted by the Clean Energy Trust on Dec. 4. The two broke down the Jumpstart Our Business Startups (JOBS) Act, which gave rise to the SEC’s rules surrounding this kind of funding.
In the past, only high net worth individuals were able to invest for equity. Now, however, startups can collect up to $1 million in a 12-month period from nearly any American. There are limitations, however, to how much individuals can contribute based on their income or net worth. Also, the transactions have to go through registered brokers or funding portals such as Second Market.
Those are the basic facts, but there’s a lot more you need to know before you jump into crowdfunding your startup.
1. You can’t do it yet. As of now, the so-called “crowdfunding exemption” under Title III of the JOBS Act is still a proposal. If you’re an early-stage startup and you’re looking for seed money, this isn’t an avenue that’s open to you yet.
2. You’ll have to register with the SEC. Legally, the only companies allowed to sell stock are registered with the SEC or exempt from registration through private placement. Since crowdfunding is an inherently public undertaking, it lacks privacy and therefore cannot be exempt. As such, crowdfunded startups must be registered, a task that can require significant funds and resources.
3. You’ll be able to advertise. Traditionally, general solicitation was prohibited, but under the proposed SEC rules, that will change to some extent. You’ll be able to announce the sale, link to the site where people can go to contribute, provide details about the securities you’re offering, and share details about your business. You won’t be able to pay anyone to promote your offering unless you can guarantee that they disclose the payment each time they mention it.
4. You’ll take on a different kind of risk. Debt is simple. You borrow money, you pay it back, and you’re done. Equity, on the other hand, requires a long-term relationship with investors and with a crowd of funders, there will be more people to manage. Also, Brown and Wood point out, crowdfunding may be looked down upon by professional investors. Finally, consider the fact that you’ll have to file annually with the SEC, resulting in financial strain and the potential for being competitively disadvantaged by making your business activities public.
As the concept of equity crowdfunding matures, the risks are likely to decrease, with rewards doing the opposite. For now, though, experts would advise startups to proceed with caution.
