3 Key SEC Rules on Crowdfunding to Raise Capital

By Brett Melson Sunday, May 22, 2016

The 3 Key SEC Rules on Crowdfunding You Need to Know

In 2016, the Securities and Exchange Commission (SEC) adopted exciting new rules that permit companies to raise money through crowdfunding

As a result, companies may raise up to $1 million in any 12-month period from a broad base of ordinary investors through the internet.

Persons contributing money will receive either an interest in the company (an equity stake) or a repayment of principal invested plus interest (through a debt instrument).

Unsurprisingly, the jurisdiction of choice for most crowdfunding campaigns to incorporate is Delaware, because the Delaware corporate law structure is the best in the world.

Previously, raising money through crowdfunding involved one party providing money to an individual or company in exchange for some tangible goods. For example, a band raising money for a new album would accept contributions from fans in exchange for future free copies of the new album or band-related goods like T-shirts, concert tickets or key chains.

These crowdfunding offerings—tokens of gratitude, in a way—were conducted through popular internet sites such as Kickstarter and Indiegogo. Now, however, crowdfunding investors can obtain a piece of the actual company or make a loan to the company instead of an investment. The SEC will likely enact other new and innovative crowdfunding campaign platforms to capitalize on the new rules.

In short, as of mid-May, 2016, the new federal crowdfunding law allowed any Average Joe or Jane to invest in startup companies. This means that both startups and small businesses will have increased access to investors and, as a result, increased access to capital.

Although the Delaware startups participating in equity crowdfunding will not be mandated to acquire a comprehensive valuation before accepting investors, there will be safeguards in place in order to protect investors. The Investor Protection Unit (part of Delaware’s Department of Justice) will be in charge of oversight.

SEC Rules for Using Crowdfunding to Raise Money

Please keep in mind these rules the SEC imposes upon companies seeking to raise money through crowdfunding:

  • Companies will need to engage in crowdfunding through qualified internet "funding portals."  Many of these portals are preparing to begin operating now that the SEC's final rules have been passed. These portals will assist companies in meeting their requirements under the crowdfunding rules.
  • Companies will need to provide certain information to the SEC, the funding portal assisting in the offering and to the investors, including (but not limited to) the following types of disclosure:
    • a statement of the target offering amount, the deadline to meet the target amount and whether the company will accept amounts in excess of the target amount
    • a discussion of the company's financial condition
    • financial statements (which, depending on the amount raised as well as other factors, may need to be reviewed by an auditor)
    • a description of the company's business and intended use of the proceeds
    • information about the Directors, officers and key owners of the company
  • Companies will also need to provide an annual statement to the SEC and investors containing all requested information.

There are also limitations on the aggregate amount that individual investors can invest in crowdfunding offerings. For example, If you earn under $100,000 per year, you are allowed to invest up to $2,000 or 5 percent of your annual income—whichever number is greater.  If you earn more than $100,000 per year, you are allowed to invest up to 10 percent of your income once every 12 months.

Although the Delaware startups participating in equity crowdfunding will not be mandated to acquire a comprehensive valuation before accepting investors, there will be safeguards in place in order to protect investors. The Investor Protection Unit (part of Delaware’s Department of Justice) will be in charge of oversight.

With the arrival of the new Securities and Exchange Commission rules, the crowdfunding community now has clear definition on how to progress and how to further the potential of crowdfunding campaigns.

Please feel free to contact us with any questions or concerns about starting a Delaware entity for your crowdfunding campaign. We will be glad to assist you.

Disclaimer

THE AUTHOR OF THIS BLOG ARTICLE IS NOT A LAWYER AND HARVARD BUSINESS SERVICES, INC. IS NOT A LAW FIRM. THE ARTICLE ABOVE IS NOT INTENDED AS LEGAL ADVICE AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. THIS SHORT ARTICLE IS STRICTLY TO MENTION SOME ASPECTS OF DELAWARE’S CORPORATION LAWS AND/OR LAWS RELATING TO OTHER FORMS OF ENTITIES WHICH YOU MAY NOT BE FAMILIAR WITH. WE RECOMMEND THAT YOU CONSULT WITH A LAWYER BEFORE FORMULATING A STRATEGY WHICH WILL BE SUITABLE FOR YOUR SPECIFIC CASE.

More By Brett Melson

There are 2 comments left for 3 Key SEC Rules on Crowdfunding to Raise Capital

Crowdfunding Software said: Tuesday, July 18, 2017

Can you please provide more details on SEC Rules and Regulations regarding fund distribution to investors if any?

HBS Staff replied: Tuesday, July 18, 2017

We do not know the details of SEC regulations in regard to crowdfunding. It would be best if you check with your accountant or finance specialist.

Thanks for reading our blog.

Janexy said: Monday, June 26, 2017

Hi, I am creating a crwdfunding web for foreigns to invest in real estate in Florida. I am looking for the best legal estructure to benefict us to advantages taxes in this way. Me gustaria poder hablar con algun asesor sobre las opciones disponibles. Thank you

HBS Staff replied: Monday, June 26, 2017

Our clients typically form a corporation in order to be able to sell shares of stock and raise capital. You can learn more about the different business entiites here:

https://www.delawareinc.com/compare-business-entities/

 

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