Crowdfunding – What It Is And How You Can Benefit

The Internet has changed many things, and now it is about to change the way companies raise money.

Since the 1930s, a company that wanted to raise money from investors had two choices: go through a very long and expensive public offering of the kind Facebook completed recently; or conduct a private offering, a prominent feature of which was the inability to reach a large number of prospective investors.

The JOBS Act signed by President Obama offers a third choice, called “Crowdfunding.” In its simplest form, a company seeking capital will register with a special kind of Internet site created for this purpose, referred to in the law as a “portal.” Prospective investors will also register with the portal. If a registered investor likes a registered company then a marriage is made—all through the portal and all online.

Probably the most important change to the securities laws in 80 years, Crowdfunding offers rich new opportunities:

    • Because the Internet portal is accessible all the time, the company looking for money can be exposed to many more investors than through a traditional private offering.
    • By registering with more than one portal, an investor on the lookout for growing, entrepreneurial companies can see many more companies than available at present.
    • The portal business is a new creature entirely, offering entrepreneurs the opportunity to get in on the ground floor of legitimate Internet-based fundraising.

The Securities Exchange Commission (SEC) is writing the final rules for Crowdfunding right now. Here are some of the most important rules and limitations you should know:

    • Crowdfunding will not begin officially until January 2013, when the SEC finishes writing the final rules. But that isn’t stopping companies and entrepreneurs from figuring out how to do business.
    • If a company raises money using Crowdfunding, it may raise only $1,000,000 from all sources during any 12 month period.
    • The law limits how much any investor can invest: for those whose income or net worth is less than $100,000, the limit is the greater of $2,000 or 5%; for those earning more, the limit is 10% of annual income or net worth, with an upper limit of $100,000. These limits refer to the total invested in all Crowdfunding investments during any 12 month period.
    • The company seeking investors will be allowed to advertise, but only to direct potential investors to the portal.
    • The company seeking investors will be required to provide fairly extensive information to potential investors. The kind of financial information—whether merely certified by the principal officer, reviewed by a CPA firm, or audited by a CPA firm, depends on the size of the company.
    • The portal will be required to register with the SEC, become a member of a national securities organization (probably FINRA), and will be responsible for many aspects of the compliance process.
    • The portal may not offer investment advice, recommendations or compensate its employees based on the volume of sales on its site.
    • Offerings conducted through Crowdfunding are exempt from the registration and disclosure requirements of state laws (so-called “blue sky” laws).
    • An investor who acquires stock through a Crowdfunding offering is subject to some restrictions on disposing of the stock.

Crowdfunding, and more generally, the ability to raise money through the Internet, is in its infancy. If Crowdfunding is the success that many expect, it seems very likely that these rules will be changed, allowing more money to be raised from additional investors in more ways. Surely, there will someday be an “app” for that.

There will be many traps along the way. To avoid the traps and discuss the opportunities, please contact me.

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