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December 10, 2015 | BusinessFrom the blog

New Regulations in Equity Crowdfunding: What You Need to Know

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Domenic Romano

Founder & Managing Partner

By now, most of us have heard of crowdfunding.  Maybe a friend started a GoFundMe to help with the cost of a trip or a neighbor started a Kickstarter campaign to assist with marketing a new product or business.  However, fewer people are familiar with equity crowdfunding.  This new type of crowdfunding allows individuals to purchase equity in smaller businesses, and allows private businesses to gain access to a much larger pool of potential investors.

Are you thinking about using this new form of crowdfunding to grow your business? Recent SEC rules allow investors with lower income and modest net worth to purchase shares in private businesses.  The regulations create new opportunities for companies who may want to tap into equity crowdfunding as a way to grow their business.  Here are some important points companies should know about the new rules.

  1. Who can invest under these new rules?

People with an annual income or net worth below $100,000 may now purchase ownership stakes in private businesses through the new SEC rules.  Old rules limited equity crowdfunding to those with an annual salary of at least $200,000 or those with at least $1,000,000 in assets.  Regulators realized that this new crop of investors may not be able to withstand large losses the same way that wealthier individuals can.  The idea that small-time investors could lose their life savings on a bad bet loomed large as the SEC decided on these new regulations.  Accordingly, the Commission placed limits on how much each individual may invest.

  1. How much money can a business take in from equity crowdfunding?

Under the new rules, businesses are restricted from raising more than $1,000,000 over a 12 month period through equity crowdfunding. An individual with an annual income or net worth below $100,000 may invest the greater of: (a) $2,000; or (b) 5% of the individual’s annual income or net worth, whichever is lower.  Individuals with an annual income or net worth greater than $100,000 may invest whichever amount is less: 10% of their annual income or 10% of their net worth.

  1. What information must a business provide to potential equity crowdfunding investors?

The rules require issuers to provide a substantial amount of information about their companies. Although not a complete list, some of the information issuers must provide includes a business plan, a certified description of the company’s financial condition, and a description of the company’s ownership and capital structure. The regulations also require that issuers disclose risk factors, information about prior indebtedness, and select financial data for the prior two fiscal years.  With all this information, the SEC hopes to arm investors with the information they need to evaluate equity crowdfunding opportunities.

  1. Where can businesses find investors who want to engage in equity crowdfunding?

This new type of equity crowdfunding can only happen through a broker or a funding portal.  A funding portal is a new type of online financial intermediary that Congress created for equity crowdfunding. It’s important to note that these new funding portals cannot offer investment advice or make recommendations.  They must also take certain measures to reduce the risk of fraud.  Interestingly, equity crowdfunding websites such as Crowdfunder.com have been up and running for a while, but until now, they could only take money from wealthier “accredited” investors.  Now, with the arrival of the new rules, businesses can use equity crowdfunding to raise money from individuals of any net worth.

  1. Why has the SEC implemented these new regulations?

First, the new rules enable ordinary individuals, no matter their net worth, to use these modern investment tools.  Second, the rules aim to protect new, and perhaps less experienced, investors from fraud and the high risk of loss that comes with investing in private businesses. Even though there are a lot of great businesses out there, most new businesses fail.  While the SEC can’t prevent investors from suffering losses, it can reduce the extent of those losses by regulating the marketplace.  The SEC wants to ensure that these investors of modest means have the information they need to invest wisely.  With increased transparency, there is less of a chance that deceitful businesses can defraud or mislead potential investors.  However, despite increased access to corporate information, it will ultimately be up to individuals to do their homework.

The new SEC rules aim to increase transparency, decrease the likelihood of fraud, and open the market to new investors for private businesses.  If you have questions about starting an equity crowdfunding campaign for your business, contact a professional who has experience working with equity offerings.

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