Friday Jun 1, 2012 by Brendan Boyle - Law Student, Boston College Law School
When people think of crowdfunding, most think of this:
Kickstarter and sites like it use the power of the internet to bring groups of people together to fund a wide variety of artistic endeavors, products, causes, and initiatives. These sites have defined crowdfunding as people banding together to fund things they believe in. Little did I know that to Congress crowdfunding means something else entirely. It’s actually an acronym, CROWDFUND, which stands for “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure.” This acronym, a silly device Congress used to make citing the bill easier, is insignificant but raises a larger point. If you want to issue stock in your company online, crowdfunding means whatever Congress and the SEC say it means, no matter how silly or odd some of the rules might seem. With that in mind, let’s dive into what Congress has told us so far.
The JOBS act amends section 4 of the 1933 Securities Act (15 U.S.C. 77d). Section 4 outlines the different types of securities offerings that are exempt from SEC IPO registration requirements. The JOBS act adds crowdfunding as an exemption. A sale of securities fits within the crowdfunding exemption if-
Part A is fairly straightforward. You can only offer up to 1 million dollars of securities a year using this exemption and non-crowdfunding securities count towards the total. This means if you raise a million dollars in venture capital, you cannot turn around and raise another million crowdfunding. Once you have sold a million dollars in securities for the year in any form, you can no longer issue equity through crowdfunding that year.
Part B is more interesting. There are some ambiguities here that the SEC must address in its regulations. The statute bases the amount a company is allowed to sell on either annual income or net worth. The question is, which do we use? Can a company use either? Also, what are the definitions of annual income/net worth? How will this be verified? Will it be enough for the investor to self-report or will more stringent measures be necessary?
Even more troublesome is the language used in the beginning of part B. Notice that I have bolded the words “the” and “an.” Tiny words can take on huge significance in legislation. In part A Congress used the phrase “the issuer,” implying they were referring to a single issuing company. In part B, however, they us the phrase “an issuer.” This could imply that Congress meant all issuers to the investor, not just the one company the investor is currently buying securities from. Congress knowingly used “an” instead of “the.” The policy behind this choice is investor protection. Congress wants to prevent middle/lower class investors from putting too much money into risky securities. This formulation raises a host of questions/problems. If you are a company trying to raise money through crowdfunding, and you need to calculate if your offering takes the investor above the 5/10% thresholds, how will you know how much someone has already spent on crowdfunding securities? Can the investor self-report? If that is not enough, who will keep track? The SEC? The funding portal? The funding portal seems like a good answer until you remember there will be hundreds of these sites. Kickstarter will not know how much you have invested on Indigogo, WeFunder, etc. High net worth individuals add another layer of complexity, as not only crowdfunding securities count towards the aggregate total of stock. For example, if an angel investor buys stock in a Regulation D offering that stock will count towards his or her aggregate total for the year. Companies will need some way to keep track of high net worth individuals’ other investments. The SEC is going to need to sort out how this is going to work. If crowdfunding gets popular enough, tracking the investments could represent a growth area for startups to get into.
I am going to address Parts C and D in future posts. If you have any questions or any ideas on how the SEC should handle the issues I raised, please post in the comments. Thanks for reading!
Brendan Boyle is a third year law student at Boston College Law School. You can find this post, as well as additional content on his blog located here. You can also follow Brendan on Twitter (@brendanboyle87) by clicking here.