Crowdfunding is a way for large groups of people to donate small amounts of money to a specific cause. Sites like Kickstarter and IndieGoGo allow individuals to donate to a cause, company, or project, usually in exchange for gifts, free products, or other fringe benefits. The Federal JOBS Act, enacted in March 2012, legalized equity crowdfunding, subject to a number of legal requirements and regulations currently being developed by the Securities Exchange Commission. Prior to the JOBS Act, obtaining securities in return for small contributions was illegal or highly impractical.
Crowdfunding is creating a new funding structure for issuers targeting up to $1 million, and it is expected that there will be limitations on the amounts an investor can invest based on their annual income and net worth. The issuer must file a comprehensive business plan, valuation of securities and financial statements with the SEC. The issuer has annual filing requirements with the SEC.
It is expected that crowdfunding will be largely internet based and will have a structure with a funding portal intermediary or broker who will have to register with the SEC and FINRA. The portal cannot offer investment advice or recruit buyers. The portal must ensure that every investor understands the investment. The portal is subject to SEC reporting requirements with respect to each issuer. The portals are commissioned with the implementation of investor protection in accordance with the instructions of the SEC.
Foreign companies cannot use crowdfunding as it will only be available to companies organized in the United States. Issuers and intermediaries are barred from using crowdfunding for previous bad acts.
In order to strike a balance between allowing issuers to raise small amounts of capital and protecting investors’ rights, an issuer is permitted to sell an aggregate amount to any investor during a 12-month period, up to:
(i) the greater of $2,000 or 5 per cent of such investor’s annual income or net assets, as applicable, where either the investor’s annual income or net assets is less than $100,000; and
(ii) 10 percent of such investor’s annual income or net assets, if applicable, not to exceed a maximum aggregate amount sold of $100,000 where either the investor’s annual income or net assets are $100,000 or more. Net worth does not include investor’s residence.
The issuer is liable for any misrepresentation and the law requires the issuer to file information and financial reports with the Securities Exchange Commission and make available to investors and the internet broker or funding portal and to make certain information available to prospective investors, including but not limited to on :
1) name, legal form, address and website address of the issuer;
2) the names of the directors and officers (and any person holding any similar status or holding any similar office) and any person holding more than 20 percent of the shares of the issuer;
3) a description of the issuer’s business and the issuer’s anticipated business plan;
4) a description of the issuer’s financial condition, including for offerings that, together with all other offerings of the issuer, have aggregate target offering amounts of $100,000 or less within the preceding 12-month period;
Also 5) the income tax returns filed by the issuer for the most recent year ended (if any); and Issuer’s financial statements, which must be “certified” by the issuer to be true and complete in all material respects if $100.00 or less is offered, and if the issuer has offered more than $100,000 but not more than US$500,000 -Dollar, financial statements that have been “audited” by an auditor independent of the issuer using professional standards, and if the issuer has offered more than $500,000 (or such other amount as may be determined by the SEC), audited financial statements;
6) a description of the stated purpose and intended use of the issuer’s intended proceeds from the issue in relation to the intended offering amount; the intended offer amount,
7) the deadline for reaching the target bid amount and regular updates regarding the issuer’s progress towards reaching the target bid amount;
8) the public price of the securities or the method of determining the price, provided that each investor is notified in writing of the final price and all necessary disclosures prior to the sale, with a reasonable opportunity to withdraw the obligation to purchase the securities.
The buyer is required to hold the purchased securities for at least one year from the date of purchase. The JOBS Act required the SEC to issue final crowdfunding rules by December 31, 2012, but there are strong indications that the SEC will not have such rules in place by that date. Until the SEC issues its final rules, stock crowdfunding is illegal.