Crowdfunding – Will it Work?

On October 30, 2015, the SEC adopted the final rules for a new crowdfunding exemption from the Securities Act of 1933. Known as Title III, the exemption forms part of the Jumpstart Our Business Startups (JOBS) Act of 2012. The JOBS Act was originally passed with bipartisan support from Congress as an initiative intended to strengthen the American economy by way of easing the compliance requirements for capital raisings.

Prior to the passing of Title III, capital raisings drawing from the general public were restricted either to costly IPO’s or Regulation A, itself an exemption from the 1933 Act which allowed unregistered public offerings of up to $5 million of securities in any 12-month period. Unfortunately, the rules governing Regulation A were extremely cumbersome and required prohibitively large legal and accounting fees in order for companies to properly comply. In fact, during the last few years so few Regulation A offerings were completed that the code section effectively became a museum exhibit. Title III was thus passed to provide a way for smaller companies and startups to connect with potential investors.

In general, crowdfunding is simply the practice of funding a company or project by raising money from the public. There are several different categories. For example, charities utilize donations-based crowdfunding, while creative projects like music albums or film projects make use of rewards-based crowdfunding. These two categories are unregulated because they are not part of the securities market. Title III deals with SEC-regulated capital raisings – typically either equity crowdfunding (selling ownership in a company in return for capital) or debt crowdfunding (also known as peer-to-peer lending, which is the practice of raising capital by offering debt securities).

Under Section 4(a)(6), Title III of the JOBS Act sets forth the following crowdfunding capital-raising limitations on the issuer and potential investors:

Title III also lays out the issuer’s reporting requirements, which are as follows:

As compared to the old Regulation A, the crowdfunding rules are much more efficient and represent far less of a commitment by the issuer in terms of time and resources. Therefore, it’s not surprising that crowdfunding activity is accelerating quickly. Massolution, which specializes in crowdfunding research, released its annual report 1 showing that the crowdfunding sector raised $16.2B in 2014, a massive increase from 2013’s $6.1B. Now that the new rules have been finalized by the SEC it’s expected that those numbers will see a similar dramatic increase for 2015 and especially for 2016 and beyond as entities begin to implement and ramp up their crowdfunding campaigns.

So will the new exemption actually be utilized by the American capital markets? From what we’ve seen thus far, the result of the new legislation is increased accessibility by both potential issuers and investors, particularly with respect to smaller companies and startups. When considering that crowdfunding rules have already been successfully implemented by other countries globally, it appears likely that crowdfunding will become a permanent fixture in the US capital markets.

The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals.