What is Crowdfunding?
Crowdfunding has revolutionized the way that companies have been able to raise capital for their business. So what is crowdfunding? It essentially is using the power of a large group of resources, in this case people, to drive down the cost per unit of a good or service. I like to give the example of Groupon, the popular site where individuals can purchase items using their collective power to drive down the cost of goods and services. (Also the reason you can go to a warehouse and pay less for 50 rolls of toilet tissue versus 40 rolls.) Ex.- Instead of you paying $150 for a widget, you pay $100 for the same widget. Why? Because the company is getting so many orders, the cost is driven down to $100 because of “economies of scale”. It cheaper to produce large quantities than smaller quantities.. Crowdfunding has a similar concept. Companies are able to raise money from a crowd of people versus 1 or a few individual investors so the cost per unit is driven down. So if a company wants to raise $1 Million, instead of raising from 4 investors $250,000, a company can raise the same $1 Million from 100,000 investors at $100 each. Got it? Good.
What does crowdfunding have to do with the JOBS Act?
The JOBS Act was passed by Congress in 2012 with the goal of generating jobs. The thought was that if access to capital was made easier to small or start up companies without the need to register or file an exemption with the S.E.C., then these companies would hire more employees. You have heard the statistics—“small businesses” (as defined by the Small Business Administration) employ between 90-95% of the jobs in the United States. The JOBS Act was signed by the President on April 5, 2012.
Before the JOBS Act, start ups and small companies had 1 of 2 ways to sell securities to investors: (1) Register with the S.E.C., which is heavily time consuming and expensive or (2) Find an exemption to registering with the S.E.C. under a Regulation D, which still needed heavy legal compliance and guidance and Regulation D had several limitations as to who (such as limited to “accredited investors” as defined under Rule 501(a) of the Act or only a certain number of “unaccredited investors”) and how much companies could raise.
Here comes the JOBS Act, specifically Section III, which was established to make it easier for small and start up companies to raise private equity through ALL types of investors, “unaccredited” and “accredited”. However, the JOBS Act was the first step as more work is still needed. The JOBS Act gave authorization for the S.E.C. to make rules around HOW this is done by authorizing the S.E.C. to develop exemptions under Section 4(a)(6) of the Securities Act. Generally speaking, however, once the rules are finalized by the S.E.C., these rules will permit small and start up companies to raise up to $1M within a 12 month period through securities crowdfunding. There are limits to the amounts that individuals can invest based on their income but now small and start up companies can raise money through smaller amounts from multiple investors, even “unaccredited investors”. And hence….the JOBS Act made crowdfunding an easier avenue for private equity fundraising.
Intrastate crowdfunding: States Are Taking Action NOW!
Because it is taking the S.E.C. such a log time to finalize its rules under Section 4(a)(6) of the JOBS Act, states have exercised a specific exemption given to them under the Securities Act of 1933 to promulgate their own rules on “intrastate crowdfunding”.“Intrastate crowdfunding” is limited to selling securities to residents of the state to businesses registered in that particular state. The details of each “intrastate crowdfunding” exemption is state specific so consult an attorney licensed to do business in a particular state.
For example, Georgia has the “Invest Georgia Exemption” which allows for Georgia based businesses to sell among Georgia residents. Florida just passed a similar intrastate crowdfunding exemption. There are about 20 states in total that have exercised this exemption. Intrastate crowdfunding is an effective way for states to take advantage of crowdfunding while the S.E.C. finalizes their rules–which the S.E.C. Commissioner states will be by the end of the year. You will need to speak with your private equity attorney to learn the requirements of your state.
NOTE: I will be discussing this subject in detail during my “Power Raisers” weekly conference call this upcoming Monday (Aug. 3rd) at 11 am. Visit the News & Eventssection of my website for more information.
There is crowdfunding and the JOBS Act in a nutshell. While this is a very legally complex issue, it does give hope to small and start up companies throughout the nation that perhaps this is another effective way to provide access to capital that was not available before the JOBS Act. We shall see but I hope you are prepared if you are thinking about raising capital to take advantage of both the federal and state crowdfunding opportunities.