SECOn Friday, the SEC approved equity crowdfunding for non-accredited investors in a 3-1 vote. This is the true equity crowdfunding from the JOBS Act of 2012 known as Title III. Given it has been more than three years to get the final rules approved, I wasn’t sure this would ever happen.

The new rules go into effect in 180 days, so there will be time to fully digest them, but here is a primer that may help you decide whether Title III equity crowdfunding is right for you.

The Basics

Before the SEC approved the rules, crowdfunding was allowed when targeted to accredited investors; or in certain states, like Texas, that approved intrastate crowdfunding; or when giving away rewards as opposed to equity in the company.  Now, companies can seek funds in exchange for equity from all investors regardless of whether they are accredited.

The Rules

To know whether it makes sense for you, take a look at the rules.

  • A company can raise up to $1 million  in a 12-month period;
  • Individuals can invest up to the greater of  $2,000 or the lesser of 5% of the individual’s annual income or net worth;
  • If the individual’s income or net worth exceed $100,000, then the investor can provide 10% of the lesser of their annual income or net worth;
  • No individual can invest more than $100,000 in crowdfunding platforms during a 12-month period.
  • Securities purchased in a crowdfunding transaction generally cannot be resold for one year.
  • All sales have to go through a broker-dealer or a funding portal.

The primary hurdle may be the disclosure requirements that companies will have to make. They include:

  • The price of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount;
  • A discussion of the company’s financial condition.
  • Financial statements which, depending on the amount offered, may include information from the tax returns, reviewed by an independent public accountant, or audited by an independent auditor.
  • If a company is raising more than $500,000 but not more than $1 million, a company can provide reviewed rather than audited financial statements, unless financial statements of the company are available that have been audited by an independent auditor.
  • A description of the business and the use of proceeds from the offering.
  • Information about officers and directors as well as owners of 20 percent or more of the company.
  • Certain related-party transactions.
  • Annual reports.

To see what exactly these disclosure requirements mean, you have to review the full approved rules available here. Full Title III Crowdfunding Rules. Warning, the pdf is over 600 pages.

Is it right for me?

So, why would a company live with these rules to raise money? In most situations, if you can raise money the old-fashioned way (through accredited investors preferably) or even use debt rather than equity, then we generally recommend you go that route. But, if you are a consumer/retail business, crowdfunding may be the best avenue for expansion. With equity crowdfunding, your customers become vested stakeholders in your business.  They become brand ambassadors and referral sources. If you want hundreds of your customers to do that, then consider the crowdfunding route that will be available to you in six months.

As you probably read, the Texas Securities Board approved intrastate crowdfunding yesterday without limiting it to accredited investors.  You can read the rules here.

For those wanting to issue equity through intrastate crowdfunding:

  • Companies may raise up to $1 million per 12-month period
  • Offerings must be carried out online through a registered dealer or crowdfunding portal.
  • The company must be a non publicly-traded Texas entity (see below) and can only offer the securities to Texans (see below for more specifics).
  • The company must have a defined business plan, investment goals and list disclosures.  This means you will have to post a summary of the offering on the portal at least 21 days before any securities may be sold. The disclosures must include risk factors, a description of the issuer’s business, operations, and management, a description of the securities and other material information.
  • Customary bad actor disqualifications apply.
  •  Non-Accredited investors may contribute up to $5,000 per offering.
  • To obtain more than $5,000 from accredited investors, the company must verify the investor qualifies as “accredited.”
  • Investor funds must be placed in escrow until the specified minimum offering amount has been raised.
  • You are allowed to provide a limited notice about your efforts and provide a link to the portal, but you can only distribute this to investors located in Texas.
  • You do not have to publish reviewed or audited financial statements unless audited financial statements are already available for any of the three years prior to the offering. Instead, the CEO can certify the financial statements are accurate and complete as of the date of the offering.

With regard to the portals:

  • Fill out a Form 133.17 with the State Securities Board, complete a background check and pay the registration fee for securities dealers in Texas registering as a restricted dealer.
  • You are not  required to pass the General Securities Registered Representative (Series 7) Exam or the Uniform Securities Act State Law (Series G5) Exam.
  • You have to limit access and trading activity to Texas.
  • The portal must confirm residency before allowing access by the investor.  The portal also has to conduct  background and regulatory checks for bad actor compliance.
  • You cannot offer investment advice, manage investor funds, or facilitate secondary market transactions, along with other restrictions.
  • You will be required to maintain certain records for five years and you will have post-registration reporting requirements and renewal fees.
  • All communications between the investors and the company raising the money must take place on open forums on the portal.
Some of the Details

Now, for those that like to dig into the details, intrastate crowdfunding in Texas is made possible because Section 3(a)(11) of the Securities Act of 1933 exempts from federal registration securities offered and sold only to persons within a single state or territory, in which the issuer is also a resident.

To issue stock as a Texas entity, you must:

  • be organized in and have your principal place of business in Texas;
  • have at least 80% of your gross revenues during the most recent fiscal year prior to the offering be derived from the operation of business in Texas;
  • have at least 80% of the your assets at the end of its most recent semiannual period prior to the offering located in Texas; and
  • use at least 80% of the net proceeds of the offering for your operations in Texas.

To invest, you must be a Texas resident which means, you must be:

  • A corporation, partnership, trust or other form of business organization with its principal office in Texas.
  • An individual who,  at the time of the offer and sale, has her principal residence in Texas.
  • If an entity is set up for the specific purpose of buying the stock, all of the beneficial owners have to be residents of Texas.

We will follow up with a more thorough analysis of this method as we digest the new rules.



My friends in the start-up community are excited about recent headlines suggesting the SEC has greenlighted crowdfunding.  Leave it to the lawyer in the crowd to suggest they temper their excitement.  As lawyers, we are used to telling people to be careful.

The News

The headlines come from two SEC actions that appear to allow AngelList and the the ability to operate as crowdfunding sites.   The SEC no action letters are linked here for and here for AngelList.

Technically, the SEC authorized AngelList and the fundersclub to receive a carried interest in the companies without having to comply with rigorous broker-dealer rules.   These sites are not simply taking 3-10% of whatever is raised by the company like some broker-dealers registered with FINRA might.  Instead, they are now allowed to take a carried interest in the companies to compensate them for raising money in what are essentially investment vehicles or funds to invest in start-ups.  This costs the founders much more out of the profits (anywhere between 20-30%) and the carried interest takes it out of the broker-dealer rules.  To read more, check out this blog post from Stephen Quinlivan of Leonard, Street and Dienard.

Both sites pre-screen and approve the companies seeking funds (although AngelList appears to have a lot of start-up that you can peruse without registering).  The investors don’t invest directly into the companies, but into investment vehicles (like a separate limited partnership or fund) which then manages the investment on behalf of all of the investors.  Therefore, it is not likely the individual investors get to vote their stock or impact management, other than through the collective investment vehicle.  Finally, both sites only allow accredited investors to participate.

What does it mean?

This is big news.  It does not mean, however, you can post your idea on Facebook and start asking for small contributions from your 2,000 Facebook “friends” of $100 each in exchange for stock in your company.

While the ruling focused on the broker-dealer exemption, it did not provide any guidance or loosen the restrictions against general solicitations of equity which is still against the law.  Importantly, the SEC’s tepid authorization of these sites was conditioned on the representation that all of the investors using the site would be accredited investors, registered and pre-screened.   Finding accredited investors interested in start-ups is easier said than done.

With regard to individuals, to be an accredited investor, the individual must:

  • Have a net worth that exceeds $1 million at the time of the purchase, excluding the value of the primary residence; or
  • Have an income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

Both sites claim to abide by Rule 506 of Regulation D which still prohibits “general solicitations.”  Rather than a true crowdfunding site that allows you to peruse various companies, you agree to invest in certain funds to be sued on start-ups and then state your interest in certain pre-screened startups.  

In the letter to the SEC, AngelList says it does not engaged in general solicitation because:

AngelList Advisors’ activities with respect to the qualification and approval of Investors should not be deemed a solicitation for any securities transaction. In particular, AngelList Advisors is proposing to impose a thirty day waiting period from the time a potential Investor submits an RFI and questionnaire until he or she closes on an investment. Consistent with the Staff’s guidance in Lamp Technologies Inc., this waiting period is designed to ensure that Investors do not join the AngelList Advisors platform to invest in a particular Investment Vehicle, and accordingly is sufficient to ensure that AngelList Advisors’ qualification of the potential Investor is not deemed to be a solicitation of an investment in the applicable Investment Vehicle.

The website is silent on the solicitation issue, but explains their process as follows:

FC Inc. and FC Management collectively identify and perform due diligence on start-up companies for which FC Management may wish to form investment funds. Once they have identified such a company, FC Management enters into a non-binding term-sheet agreement with that company on a target amount of capital which a limited liability investment fund managed by FC Management would invest in that company. FC Inc. then posts information about that start-up company, provided by the start-up company, on its website. The name of and information about a start-up company is available online only to FundersClub members who have already been qualified as accredited investors. FC Inc. makes available the investment fund which will invest in that company for its members to offer non-binding indications of interest. FC Inc. provides those members who express indications of interest in an investment fund with standardized legal documentation through which they will invest in that investment fund. When an investment fund reaches indications of interest sufficient to fund the target amount originally agreed upon between FC Inc. and the start-up company (or if the company agrees to increase the target level of capital), then FC Inc. closes the indication of interest process. FC Inc. then reconfirms the indication of interest with each member who has offered the indication of interest and reconfirms the accredited investor status of each of those members. Simultaneously, FC Inc. negotiates the final terms of the investment fund’s investment with the start-up company. That negotiation may include the management rights that FC Management will have in the start-up company after the completion of the investment fund’s investment in the start-up company.

Yes, this is a big step.  It may even be the first step toward loosening general solicitation restrictions.  It does give guidance on broker-dealer requirements, but almost no guidance or even clearance of where the line is on general solicitation restrictions. 

BREAKING NEWS:  Crowdfunding is legal.  Sort of.  Before you start soliciting for investors on Facebook, you need to know that general solicitations to sell equity to your company not listed on the stock exchange or otherwise registered is still illegal.  That doesn’t mean you can’t engage in some form of what is considered crowdfunding.

I recently took part in a UHSBDC presentation called “Crowdfunding for Small Business” with the founder of Buffalo Bayou Brewing Company, Rassul Zarinfar.  I was supposed to talk about the JOBS Act and he was assigned to discuss how he raised his needed capital to start his craft brewery from about 50 different people.  He had a lot to talk about.  I got to discuss Reg D.  You can check out the informative slides from the presentation here:  UHSBDC Crowd Funding Power Point.

Last April’s JOBS (or Jump-Start Our Business Start-Ups) Act was supposed to make it easier for entrepreneurs to raise money using Kickstarter-like campaigns so start-ups could raise small chunks of money from many investors via the internet without worrying so much about Reg D.  I wrote this post about it on the day it was signed into law.

The SEC was supposed to issue specific regulations for crowdfunding to strike the balance between easier access to capital and preventing widespread fraud against unsophisticated investors.  Their deadline was originally December 2012.  The December 2012 deadline came and went.  Alas, the brewery founder was the star of the show.  Side note: he probably would have been the star anyway because he founded a craft brewery and I was going to discuss detailed securities regulations.

Crowdfunding Now

So, we spent most of our time at the presentation discussing how to “crowdfund” under existing laws.  Much of Buffalo Bayou Brewing Company’s story is revealed in the Power Point presentation we used.  In short, Rassul convinced his friends and friends of friends to invest without making a general solicitation for investors.  Technically, he used Rule 505 of Regulation D which allowed him to raise up to $5 million (he raised about 10% of that), from as many accredited investors and up to 35 non-accredited investors.  You can read more specifics about the various rules and what it means to be an “accredited” or “sophisticated” investor on the presentation.  The SEC also does a good job of explaining Rules 504, 505 and 506 which are exceptions to the general rule that requires you to register with the SEC.

He had to invest some of his own money to pay lawyers (another reason to love him besides his great beer) to put together a Private Placement Memorandum, or PPM, that disclosed to his investors all of the risks.  He also had to be careful and document exactly how he shared his PPM and who he targeted to comply with existing laws because you cannot make a general solicitation for unregistered equity.  Have I said this enough.  While it sounds like rainbows and unicorns, he now answers to 50 shareholders.  He also concluded his second round of funding which came with its own set of headaches dealing with his original investors and their redemption rights.

Crowdfunding in the Future

The current expectation is that the SEC may have the new JOBS Act crowdfunding rules in place by the end of this year.  Had they been in place, Rassul could have simply posted a video on a website, made some disclosures and asked the general public to invest in his brewery and sat back and watched the money come in from hundreds of investors each pitching in a few thousand dollars each.  Because of the special relationship between founders and shareholders, Rassul still has reservations about this proposed process from the entrepreneur’s perspective.

Nevertheless, the new rules are supposed to allow companies to raise up to $1 million.   Investors with a net worth of less than $100,000 will be allowed to invest 5% of their yearly income or $2,000, whichever is higher.  People with more money will be allowed to invest more, up to 10% of their income.  Under the proposal, a company with $1o million in assets would not have to register with the SEC until they obtain 2,000 investors (500 of whom can be non-accredited).   The SEC will also allow a five-year phase in plan for companies with less than $1 billion in annual revenues.

Many people have seen this as an opportunity to easily create a website, a la Kickstarter,  taking a small cut as easy money.  This is not a technology or web play because that is the easy part.  This is an opportunity for those into compliance and accounting because the devil will be in the the details.

Full time securities lawyers, of which I am most certainly not one, have voiced great skepticism to me that this will ever come to fruition.  They wonder:

  • What disclosures will be required on these websites?
  • What prevents an investor from investing his maximum on one website and then going to next site and investing more?
  • Same thing with companies using more than one site?
  • How do you confirm the investor is accredited or sophisticated?
  • How do you enforce transfer restrictions?
  • What happens when the accredited investor transfers his stock and how do you keep track of the numbers?
  • What do you do about rights of redemptions?
  • How do you protect unsophisticated investors from being diluted?
  • Can bundlers or finders take people’s money and then invest on these sites and what rules will apply to them?

The questions are numerous which is one reason it is taking more time to promulgate the rules.

Rassul and I will do an encore performance for the UHSBDC on Crowdfunding for Small Business on March 26, 2013.

President Obama is scheduled to sign the JOBS (Jump Start Online Business Startups) Act today that includes provisions to relax the rules on raising capital for equity to allow for crowdfunding.   See, sometimes the Government can work together to get things done. 

But, like with everything else, the devil is in the details — details that will be hammered out over the next few months and hopefully with the eye of letting us make some mistakes along the way.  You can read the CNN story on the law here.

Crowdfunding for start-ups

In short, the new law will make it easier to allow crowdfunding for actual investors.  Before now, a site like KickStarter, could raise money online from a large group of people, but not in exchange for stocks.  Currently, the law makes it difficult to solicit funds from a large amount of investors who are not considered “accredited” investors.  To be an accredited investor you have to have more than $1 million in assets excluding your residence or $250,000 in income for the last two years for an individual; i.e., rich.

With passage of the JOBS Act, companies can now raise up to $1 million through crowdfunding.  Investors with a net worth of less than $100,000 may now invest 5% of their yearly income or $2,000, whichever is higher.  People with more money will be allowed to invest more, up to 10% of their income. The ball is now in the SEC’s court to lay out some more detailed regulations. 

Does it help more established companies?

Currently, if a company has 500 or more investors or is raising $5 million, the company has to file a lot of paperwork with the SEC.  Securities lawyers like that — companies don’t.  Under the new law, a company with $1o million in assets would not have to register with the SEC until they obtain 2,000 investors (500 of whom can be non-accredited).   The SEC will also allow a five-year phase in plan for companies with less than $1 billion in annual revenues.  

What’s the downside?

The main concern is fraud.  It will be easier for companies with nothing more than in idea to swindle investors.  This is always the balancing act of a mixed economy.  We want to have a free and robust market while protecting the unsuspecting. 

Yes, there will be more fraud.  People were swindled before this law and will be after.  But, I’ve got to believe people who want to invest in startups through crowdfunding will be going in with their eyes open.  My retired parents don’t invest in start-ups, don’t electronically day trade and I don’t suspect they will suddenly go crazy doing it online.  To allow for this process, we, as a society, are going to have to accept a little more risk. 

This is an idea whose time has come.  It is already legal in parts of Europe.  Let’s give it a try and see how it goes.  If the world starts falling apart, then we can pull back.  This will open up a whole new marketplace.  If there’s rampant fraud, investors won’t be there long and the free market will force investors somewhere else.  It will still be illegal to make fraudulent representations and you can still go to jail.  

What’s Next?

The law calls for the SEC to provide more guidance about how this will work.  Will licensed brokers have to be involved?  Will there be licensed and regulated intermediary websites?  What reporting requirements will there have to be?  What information will have to be revealed to seek crowdfunding?  There are a lot of questions left to be answered.  The law is promising, but the good feeling could be doused if the SEC makes it too difficult to invest $2,000 in your buddies’ start-up. 

I recently started to let my kids cross the street on their own in our neighborhood.  It’s good for everyone.  They become more independent and grow.  I get to witness and harness this.  They get to visit friends.  The first time they forget to look for traffic, however, they will lose some of that privilege.  Let’s hope the SEC does the same when they get to the details.  Crowdfunding is growing up.  It’s time to let it cross the street on its own.  

You can read the text of the Act here.