Between the Colorado Business Law Institute and Denver Startup Week, October was ripe with exciting events for attorneys in Denver interested in the entrepreneurial community. After speaking with attorneys and entrepreneurs alike, it is clear that great interest exists surrounding the forthcoming federal regulations in The JOBS Act (“Act”) pertaining to “crowdfunding.” Although there is hope that this funding model will be a great source of capital for wanting entrepreneurs, legitimate concerns exist that regulations will be too strict when implemented at the Federal level. This two-part piece will briefly introduce the idea of crowdfunding, explore how it fits with traditional start-up financing options, and identify potential issues.
Crowdfunding will enable companies to raise capital by seeking funding from a large number of unaccredited investors in relatively small amounts without violating SEC registration and solicitation rules. Title III of the Act specifically permits companies to leverage the internet for this purpose through “funding portals.” At its core, crowdfunding is a simple idea. By way of example, it will enable entrepreneurs from various geographic locations to advertise the efficacy of their start-up entity through social media outlets to individuals in Denver, among other locations, and an interested Denverite could then invest limited funds with that start-up entity. As a result, a wider base of capital will exist for start-up companies to tap into, thereby complementing traditional funding avenues. This is important because less than two percent of start-up companies are ultimately funded by traditional angel investors or venture capitalists.
Crowdfunding rules and regulations are currently being debated and will be issued by the SEC in 2013 – nothing is final yet. As it stands, Title III of the Act will permit participating companies to sell up to $1 million in securities while remaining exempt from the requirements of Section 5 of the Securities Act. In addition to this cap, proposed restrictions on investors will limit crowdfunding investing to an amount tied to their annual income or net worth. Despite these restrictions, this is an exciting shift in the investment paradigm for entrepreneurs because the new rules will remove the strict restrictions on companies advertising and selling securities to unaccredited investors. Instead, companies will be able to solicit investments directly from unaccredited investors through an intermediary funding portal.
Crowdfunding is not a new idea. Rewards-based crowdfunding has been in existence for years without violating SEC rules and is popular for philanthropic and entrepreneurial causes. In this model, individuals invest money with a company or individual, but only as a donation or for some type of reward – there is no expectation of financial profit. Additionally, some companies are beginning to use existing state securities laws which exist in many states, including Colorado, to setup investment crowdfunding platforms that carefully work within the federal framework. This is a detailed topic beyond the scope of this entry.
This is Part 1 of a two-part series. Stay tuned for Part 2.