Crowdfunding: A New Way To Ask Friends For Money

by Jamey R. Campellone

On Wednesday, October 23, 2013, the Securities and Exchange Commission (“SEC”) voted unanimously to propose rules under the Jumpstart Our Business Startups (JOBS) Act that would permit and regulate companies to offer and sell securities through crowdfunding. The SEC allows a 90-day public comment period before reviewing the comments and finally approving the proposed rules.

Crowdfunding is a term used to describe a growing method of raising capital though the Internet. This funding method has been used to generate financial support for such things as artistic endeavors like films and music recordings, typically through small individual contributions from a large number of people. In exchange for a pledge to the project, contributors usually receive some token of appreciation related to the project they are funding. However, crowdfunded projects are not selling ownership in the projects to their contributors.

It is clear that crowdfunding can be used to raise funds for many things. However, before recently it generally fell outside the securities arena. That is because offering a share of the financial returns or profits from business activities could trigger the application of the federal securities laws, and an offer or sale of securities must be registered with the SEC unless an exemption is available.

Titles III of the JOBS Act created an exemption under the securities law so that this type of funding method can be easily used to offer and sell securities as well. SEC Chair Mary Jo White noted that the intent of the JOBS Act is to make it easier for startups and small business to raise capital from a wide range of potential investors and provide additional investment opportunities for investors.

Consistent with the JOBS Act, the proposed rules would among other things permit individuals to invest subject to certain thresholds, limit the amount of money a company can raise, require companies to disclose certain information about their offers, and create a regulatory framework for the intermediaries that would facilitate the crowdfunding transactions. The crowdfunding sites would be required to provide investor education materials, and they would be prohibited from offering investment advice or making recommendations. This proposal would give portals some flexibility on how they make money, including on commissions based on the deals done on their sites.

Opponents of the prosed rules argue that this still creates a complex, costly regulatory framework, and complying with this new framework is likely to be intimidating and cost-prohibitive for exactly the sort of small businesses and entrepreneurs conventional crowdfunding often attracts. Additionally, crowdfunding may pose some dangers to mom-and-pop investors. But really, the biggest threat of crowdfunding may be to venture capitalists.

The SEC’s aim is to help startups and small businesses raise low-dollar-value capital more easily, without facing the current regulations on venture capital investments. If the rule passes, startups will not be forced to beg them for money anymore. Thanks to both general solicitation and now crowdfunding, entrepreneurs will be able to ask everyone for monies. From the vantage point of a past small business owner, this is a step in the right direction. The opportunities to get funding without having to go hat-in-hand to a bank or to a venture capitalist are enormous. Crowdfunding could prove to be a benefit for entrepreneurs across the country. And this is a good thing.

To read more about the new crowdfunding rules, please click here