On May 16, 2016, the SEC implemented REGULATION CROWDFUNDING (SEC Rules) under Title III of The Jumpstart Our Business Startups Act (Title III) passed by Congress in 2012. Title III established a structure for U.S. startups and small businesses to raise money through Internet crowdfunding. The SEC Rules implemented the provisions of Title III.

What Is Crowdfunding?
Crowdfunding is a web-based method used by individuals and entities to raise money by soliciting small contributions from a large number of people (the “crowd”) over the Internet.

Types of Crowdfunding
Although popularized by the arts and music community as a rewards-based way to finance music and film projects, today crowdfunding can be debt-based, donation-based, or, in the case of Title III, equity based.

Reward-based crowdfunding primarily serves artistic projects and promises the contributor one of the products produced from the contribution, e.g., free download of a music album funded by the contribution.

Debt-based crowdfunding, also known as peer-to-peer lending (P2P), allows borrowers to apply for unsecured loans from the crowd. Donation-based crowdfunding is used by charitable organizations and individuals to raise money from the crowd to pay for disaster relief and emergencies.

Title III is an equity-based version of crowdfunding that allows private U.S. companies to raise capital by soliciting small contributions from the crowd (investors) over the Internet. Historically, the Securities Act of 1933 (Securities Act) has required companies raising capital to register the transactions with the SEC unless otherwise exempted. Title III created a new exemption to the Securities Act that exempts certain crowdfunding transactions from registration. Under this exemption, qualifying U.S. companies (referred to in Title III and SEC Rules as “issuers” because they are offering to issue (sell) shares of their business to investors) may raise capital by soliciting contributions from large numbers of people (the “crowd”) over the Internet without registering with the SEC (Crowdfunding Exemption).

Crowdfunding Exemption Limits
The Crowdfunding Exemption has limitations, and, consequently, puts restrictions on the amount of money issuers are allowed to raise, and, on the amount investors are allowed to invest.

Issuers are permitted to raise a maximum aggregate amount of $1 million in a 12-month period.

Investors with an annual income or net worth less than $100,000 are permitted to invest the greater of $2,000 or 5 percent of the lesser of their annual income or net worth over the course of 12 months.

Investor’s with an annual income and net worth equal to or more than $100,000, the investment limit is 10 percent of the lesser of their annual income or net worth.

The SEC Rules
The following chart illustrates the limitations:

Investor Annual Income Investor Net Worth Calculation Investment Limit
$30,000 $105,000 Greater of $2,000 or 5% of $30,000 ($1,500) $2,000
$150,000 $80,000 Greater of $2,000 or 5% of $80,000 ($4,000) $4,000
$150,000 $100,000 10% of $100,000 ($10,000) $ 10,000
$200,000 $900,000 10% of $200,000 ($20,000) $20,000
$1,200,000 $2,000,000 10% of $1.2M ($120,000)

$100,000 cap


Registered Intermediary: Broker-Dealer or Funding Portal
The Crowdfunding Exemption also requires that all crowdfunding contributions solicited by issuers be conducted exclusively through a “platform”, an Internet program or application for the offer or sale of securities, operated by a “registered intermediary”.

A registered intermediary must be either a broker-dealer or “funding portal”. Broker-dealers have been around for decades and are authorized by the SEC to offer investment advice and recommendations to investors. Funding portals are a new type of registered intermediary created by the Crowdfunding Exemption. The function of funding portals is to operate as a platform for issuers and investors to offer, sell and buy securities (e.g., shares of stock). They are a platform to facilitate the transactions between the issuer and the crowd.

Unlike broker-dealers, funding portals may not offer investment advice or make recommendations to, or solicit investments from, investors. However, both broker-dealers and funding portals are required to register with the SEC and FINRA (Financial Industry Regulatory Authority).

The Crowdfunding Transaction
The SEC Rules require that each issuer conducting a crowdfunding transaction disclose, at a minimum:

  • Description of the company (issuer): name, legal status, physical address, website address.
  • Factors that make the investment speculative or risky.
  • Financial condition of the company (issuer).
  • Names of directors, officers and each beneficial owner of 20 percent or more of the company (issuer).
  • Price of the securities.

Registered intermediaries are required, at a minimum, to:

  • Provide educational materials to investors about the risks and costs of investing in the securities.
  • Provide information about the company (issuer).
  • Obtain a representation from the investor that he/she understands the risks involved in the investment, that they may lose all their money, and, they can bear the loss.
  • Provide materials to assist the investor in recognizing the risk of the issuer’s investment.

Once an investor has made an investment commitment on the registered intermediaries’ platform for a crowdfunding offering made by an issuer, he/she has up to 48 hours prior to the end of the offer period to change his or her mind and cancel the investment commitment for any reason.

Once the offer period is within 48 hours of ending, the investment commitment cannot be canceled. However, if the issuer makes a material change to the offering terms or other information disclosed to the investor, the investor will be given 5 business days to reconfirm the investment commitment.

One final constraint on an investor relates to his/her ability to sell or transfer the securities (shares of stock) purchased from the issuer. Crowdfunding investors are restricted from reselling their shares of stock for the first year unless they are transferred:

  1. To the issuer who sold the shares
  2. To an accredited investor
  3. To a family member
  4. In the event of death or divorce
  5. To a trust controlled by the investor or created for the benefit of a family member of the investor
  6. As part of an offering registered with the SEC.

Crowdfunding the Phenomenon
Recent statistics indicate that in 2014 crowdfunding platforms raised $16.2 billion world-wide, a 167% increase over the amount raised in 2013.

North American crowdfunding contributed $9.46 billion to this pot.

Equity-based crowdfunding (of which Title III is representative) amounted to $1.11 billion. The average equity-based global campaign raised $275,461.

If you are considering a crowdfunding campaign or investing in a campaign, contact a professional lawyer for business advice today at Anthony J. Madonia & Associates, Ltd. Do not wait to get the help you need, call us at (312) 578-9300.

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