What Is Equity Crowdfunding?

Raising the capital necessary to successfully launch a small business is perhaps the most difficult hurdle for most entrepreneurs. Common options include maxing out multiple credit cards or taking out bank loans, both of which present personal financial risks. Venture capitalists and angel investors, meanwhile, are focused on multimillion-dollar investments in companies poised for rapid growth.

With the advent of equity crowdfunding, however, even individuals with just a few hundred dollars to invest can get in on the game and take an ownership stake (however small) in the company. Below is an overview of this emerging area of business financing, which is well-suited to smaller businesses typically passed over by larger investors.

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The Basics of Equity Crowdfunding

At its essence, “crowdfunding” is a form of fundraising in which a startup (or even just an individual) raises small amounts of capital from a large pool of investors, typically through an online intermediary. Many of these intermediaries, such as Kickstarter and GoFundMe, are limited by the inability of companies to offer equity in exchange for contributions. Instead, they typically offer unique rewards that correspond with the funding level. For instance, someone making a modest contribution toward the publication of a book may receive a signed copy of the book once it’s in print.

Equity crowdfunding, on the other hand, is a type of crowdfunding that involves an exchange of capital for equity. As with traditional equity investors, those investing through an equity crowdfunding intermediary risk losing their money entirely but also may see exponential returns. What’s different is the crowdfunding platform, which allows direct interaction between the company and the investors, and the size of the investments.

Equity Crowdfunding and the JOBS Act

On September 23, 2013, the Securities and Exchange Commission (SEC) enacted rules under the Jumpstart Our Business Startups (JOBS) Act that paved the way for companies to sell securities (equity) through crowdfunding. Companies may raise up to $5 million — in aggregate — through crowdfunding campaigns in any 12-month period. As of this writing, the SEC allows accredited and non-accredited investors to participate. 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 if married

• 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

Those who are considered accredited investors may invest as little as $1,000 in a deal, depending on the crowdfunding site, in exchange for a proportional slice of the company’s stock. Investors usually hedge their bets by investing in several startups, since most ventures do not succeed, but just one success has the potential to make up for the losses.

Title III: Equity Crowdfunding for the Masses

The SEC enacted Title III of its Regulation Crowdfunding rules on May 16, 2016, opening up equity crowdfunding to lower-income individuals, with limits on the amount of money able to be invested. Within a given 12-month period, non-accredited investors may only invest the greater of $2,500, or 5% of the greater of the investor’s annual income or net worth, if the investor’s annual income or net worth is less than $124,000; or 10% of the greater of the investor’s annual income or net worth, not to exceed an amount sold of $124,000, if both the investor’s annual income and net worth are equal to or more than $124,000.

Disclosures

Title III of the JOBS Act requires companies engaging in equity crowdfunding to file certain disclosures with the SEC and the online intermediaries conducting the transactions, while making this information available to current and potential investors. Companies will be required to disclose information about the following:

• Officers, directors, those with a 20% (or more) ownership stake in the company

• Company description and explanation of how the proceeds will be used

• Price of securities being offered to the public, deadline to reach target amount, any applicable limits to investments in excess of target amount

• Company’s financial condition

• Transactions among related parties (subsidiaries, partners, other investors, etc.)

• Certain financial statements

Learn How Equity Crowdfunding Can Help Get Your Business Off the Ground

Raising capital is tough, especially for small business owners who aren’t necessarily on the radar of the venture capital community. For many entrepreneurs, equity crowdfunding presents a unique opportunity to raise substantial capital from a large number of small investors without the need for risky loans. Get a head start today by ordering Crowdfunding: Practical Guide to the SEC’s Final Rules for Raising Capital, published by Thomson Reuters.

Get Legal Help with Equity Crowdfunding

A business attorney in your area can help explain how crowdfunding works and identify equity crowdfunding platforms. Additionally, they can navigate complex SEC compliance, review Form C disclosures, and ensure adherence to investment limits.

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