Crowdfunding and The JOBS Act

In 2012, the Jumpstart Our Business Startups Act (JOBS Act) triggered a series of rule changes related to capital formation, registration, and disclosure under U.S. securities law. Among other things, the JOBS Act provides exemptions to security offerings registration for crowdfunding endeavors.

This article explains the basics of crowdfunding, SEC rules, and exemptions to crowdfunding offerings under the JOBS Act.

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What Is Crowdfunding?

The term "crowdfunding" is when large numbers of people ("a crowd") pay relatively small amounts of money ("funding") to a campaign. The campaigns can be for social causes or new business ventures. Crowdfunding is now also a way to build venture capital.

In many crowdfunding campaigns, donors get a small token of appreciation like a T-shirt or a sticker, or nothing at all. They aren't "investors" in the traditional sense.

But in an equity crowdfunding campaign, people buy "securities." Before the JOBS Act, U.S. securities laws did not allow equity crowdfunding, which, by definition, involves a public offering to the crowd.

Securities Regulation Basics

There are two important securities laws to be aware of: The Securities Act of 1933 (the "1993 Act") and the Securities Exchange Act of 1934 (the "1934 Act"). The U.S. Securities and Exchange Commission (SEC) regulates securities investment opportunities.

In general, securities are tradeable financial assets such as:

• Stocks
• Bonds
• Options

But the U.S. Supreme Court broadened the definition of securities in SEC v. Howey to include "investment contracts." According to the Court, an investment contract is a contract, transaction, or scheme where a person invests their money in a common enterprise, and they are led to expect profits solely from the efforts of the promoter or a third party.

If an offering meets these requirements, it must follow the rules set out in the 1933 Act and the 1934 Act. For example, the 1933 act's requirements include anti-fraud provisions requiring offer registrations and security sales.

The JOBS Act and SEC Registration Exemptions

The JOBS Act (Title III) changed the rules relating to private securities offerings. The Act allows companies to use certain types of unregistered public offerings.

The JOBS Act created new exemptions from SEC registration for three types of securities: accredited investors, Regulation A+ offerings, and Regulation CF offerings.

"CF" stands for "crowdfunding." Below, we touch on the basics of accredited investors and Regulation A+. Then, we'll dive into Regulation CF.

Accredited Investors

Title II of the JOBS Act is "Access to Capital For Job Creators." It allows entrepreneurs to take out advertising, create websites, etc., to reach members of the general public. This section is limited to "accredited" investors only. The JOBS Act eliminated the 90-year-old ban on "general solicitation" for this type of offering. This exemption became effective on Sept. 23, 2013.

An "accredited investor" can be a person or an entity (company).

An accredited person:

• Has an income of more than $200,000 in the last two years if single
• Has an income of more than $300,000 in the last two years
• Has a net worth of over $1 million (single or married)

Accredited investor entities are:

• A trust with assets over $5 million that was not specifically formed to buy the subject securities
• An entity where all the equity owners are accredited investors

Title II relies on rule 506 of Regulation D. These offerings have no dollar limit. There are very few other limitations.

Regulation A+

The SEC created Regulation A+ exemptions based on Title IV of the JOBS Act. The exemptions took effect on June 15, 2015.

Regulation A+ requires a review, or "qualification," of the offering by the SEC. Once qualified, the offering may get sold to anyone who meets investment limits.

There are maximum fundraising limits for Regulation A+. One tier has a limit of $20 million. The second and final tier has a limit of $50 million.

Regulation CF

Title III of the JOBS Act addresses crowdfunding exemptions. The rest of this article discusses these exceptions. It became law on May 16, 2016.

Crowdfunding Issuer Requirements

Under Regulation CF, an issuer is a small business offering crowdfunding or security.

In any 12 months, individual investors have a limit to the amounts they can invest. The total amount across all crowdfunding offerings is based on annual income or net worth.

• When annual income or net worth is less than $107,000, the person can invest the lesser amount of $2,200 or 5% of their annual income or net worth.
• When annual income and net worth are over $107,000, then the person can only invest up to the lesser of $100,000 or 10% of their annual income or net worth.

Issuers must disclose the following:

• Officer and director information
• Owner information where the owner has at least 20% interest
• A description of the issuer's business
• Details on the use of the proceeds from the offerings
• Securities pricing offered to the public
• How the securities pricing was calculated
• The final amount sought
• Deadline to reach the target offering
• What happens if the issuer raises more than the targeted amount? Is it refunded, or will it go toward another offering?
• Certain related-party transactions
• Description of the issuer's financial condition
• The financial statements of the issuer
• Tax returns of the issuers as long as an independent auditor or public accountant reviewed them
• Any amendments if there are material changes during the offering period
• Updates on the issuer's progress toward reaching the target offering

A company may raise in any 12 months a maximum aggregate amount of $1.07 million in equity crowdfunding offerings conducted through a registered broker-dealer or funding portal.

Exceptions to Crowdfunding Issuers

For the most part, any United States company may conduct crowdfunding offerings under Regulation CF. But there are some exceptions, including:

• Previously registered and reporting SEC
• Certain investment companies
• Disqualified companies
• Companies that fail to follow the annual reporting requirements
• Companies without a specific business plan
• Companies that indicate a merger or acquisition with an unidentified company or companies

If you are considering crowdfunding, speak to a securities lawyer to ensure your small business and solicitation qualify.

Crowdfunding Intermediary Requirements

To qualify for exemptions, the crowdfunding offering must happen through an SEC-registered broker-dealer or "funding portal." This is an intermediary.

The offerings through the intermediary must:

• Educate potential investors
• Be careful to reduce the risk of fraud
• Provide contact information and details about the issue
• Provide information and details about the offering
• Provide a way for potential investors to discuss the offerings on the intermediary's platform
• Help with the offer and sale of crowdfunded securities

Make sure you understand advertising disclosure requirements before agreeing to any intermediary agreement.

Get Help From a Crowdfunding Lawyer

SEC regulations and the JOBS Act crowdfunding exemptions are complex. Ensure you fully understand the laws by scheduling a consultation with a securities lawyer.