Is Crowdfunding Right For You
During the depths of the Great Financial Crisis, Congress became very concerned with the stubbornly high level of unemployment and how this was weighing on the US economy. Additionally, the Federal Reserve in the US is given two mandates; first, manage the rate of inflation and second, make monetary policy decisions that lower the unemployment rate when it becomes unacceptably high.
To put some energy into lowering the unemployment rate and help start new businesses, in April 2012 a new law was signed to jumpstart business start-ups known as the JOBS Act or Jumpstart Our Business Startups Act.
At the April meeting of the Sacramento County Bar Association, a presentation was given by Mr. Roger Linn who’s an attorney practicing with Barnett and Linn in Roseville, CA about this new law and how it’s affecting business start-ups and particularly those that are looking for finance. If you are either looking to invest your money into a business startup or raise capital to use in your new business, be aware of the following.
- The US federal regulator with the responsibility for protecting investors is the Securities and Exchange Commission or SEC. However, the very purpose of the JOBS Act was to help aspiring business owners raise working capital and to do this meant increasing and decreasing regulations the SEC administer or creating more risk for investors.
- There are other groups at both a State and international level that try to protect investors and this includes the North American Securities Administrators Association or NASAA. This is the oldest organization (having been around since 1919) whose primary mandate is also to protect investors.
- Historically the SEC recognized different classes of investors. If you had at least $1 million in net worth or an annual salary of $300,000, you were deemed to have some sophistication as an investor and therefore able to properly evaluate the risks of investing in a particular company.
- Under Section 4(6) that was part of the new JOBS Act, anyone could be solicited by and invest in a company’s securities offering without first registering with the SEC as long as the investment did not exceed the greater of $2,000 or 5% of that person’s annual income of net worth.
- Due to the power of the internet, the JOBS Act saw a large number of public offerings being made through “funding portals,” for example, Kickstarter, Indiegogo and CrowdCube. As of 2012, according to Wikipedia, there were over 450 crowdfunding platforms.
- The role of these funding portals is to connect investors with those business owners that are seeking capital. The role of these funding portals is still evolving including the disclosures they give and are required to give to each party.
- If you choose to invest through one of these “funding portals’ make sure you know what you get. Often you are simply getting a product or service the start-ups creates or sells but you do not get any equity in the start-up so if the start-up hits a home run and becomes very successful, it will not increase the value of your investment. For example, I have a friend, Tamara Dorris who has written about 11 books. She’s writing her next book and to raise funds to offset her costs she is looking for investors. There are different levels of investment but her ‘dividend’ for those that invest in her new book include free copies of books that are signed or have some other value she is disclosing.
- Companies that accept money from crowdfunding are also required to provide a set of ‘quality’ financial statements. The ‘quality’ varies depending on the amount of funding the company receives.
- Portals that receive funds for crowdfunding require a license from the SEC as either a ‘broker-dealer’ or ‘funding portal’ so this provides some safeguards to investors.
- These crowdfunding portals are also required to provide investor-education material, explaining the substantial risks involved in investing in new or small businesses and establish an investor questionnaire which demonstrates each investor’s understandings of risk, illiquidity and other related matters.
- If companies use crowdfunding to attract investments they will be found liable if any of their disclosure material contained an untrue statement of a material fact or omitted to state a material fact. This liability extends to the directors, managers and executive officers of the issuing company.
- Investors purchasing securities through crowdfunding must hold the investment for a minimum of 12 months unless the securities are sold back to the issuer, an accredited investor or to a family member due to a change of circumstance such as divorce.
The bottom line is as follows. When the JOBS Act was passed into law it required the SEC to interpret the new legislation and give guidance to those companies that wanted to raise and provide capital to small businesses. The NASAA is very uncomfortable with some of the protection to investors as you can see by going to the home page of their website – www.nasaa.org.
If you plan to invest money through a crowdfunding portal such as Kickstarter or Indiegogo, these web engines are up and running and will gladly take your money. Be aware that a lot of the rules and regulations are still evolving.
If you plan to look for money through crowdfunding for your small business be aware of the same; that is rules and regulations are still evolving.
If you would like more information about selling a business or a related service such as valuing a business, please visit my webpage Services and choose from the drop down menu the information you would like. For more immediate help, send an email to Andrew Rogerson or give me a call on 916 570-2674.