If you own or are starting a small business, we don't have to tell you how tough it is to raise capital from outside investors. Persuading someone to risk money on your company is difficult enough. But even finding that someone is a challenge, for many reasons, including legal restrictions against advertising for investment.
Federal and Maine securities laws allow you to solicit investments from a very limited number of people you already know. But how do you reach potential investors you don't know? Three alternatives you might consider under current law are: a small registered public offering; a private placement through a licensed securities broker; or pitches to venture capital firms and other professional investors.
Starting sometime next year, business owners will have another option for locating investors. The new Jumpstart Our Small Business Startups Act allows small companies to engage in non-registered public offerings of up to $1 million per year through "crowdfunding" transactions. Here are some key features and conditions of crowdfunding:
Crowdfunding is not allowed until after the Securities and Exchange Commission adopts detailed regulations. The JOBS Act gives the SEC broad discretion in setting rules that will govern these offerings. The new rules are supposed to be ready by Jan. 1, 2013. However, crowdfunding is complicated and controversial, and it is very possible that the SEC will take longer than this.
Crowdfunding offerings must be conducted through a registered broker or a registered funding portal. The $1 million cap might offer too little incentive for a traditional broker to take the lead role in a crowdfunding offering. However, several other companies have announced an intention to register with the SEC as "funding portals." Portals will act as bulletin boards for the posting of permissible crowdfunding offerings. Unlike registered brokers, portals will not be allowed to actively solicit purchases or offer investment advice or recommendations.
The JOBS Act lists several topics that a company must address in written disclosures to prospective investors, and the SEC will likely require additional disclosures. For offerings greater than $100,000, the company will need to provide financial statements that have been reviewed or audited by an independent outside accountant, under standards to be defined in the SEC's crowdfunding rule.
The company must strictly limit the maximum investment per investor. The JOBS Act limits the maximum amount of securities a company may sell to an investor within any 12-month period. The general limit is $2,000 per investor, except that those with net worth exceeding $40,000 may invest up to 5% of net worth, and those with net worth of $100,000 or more may invest up to 10% of net worth (but not more than $100,000).
The company may engage in only limited advertising of the offering. The statute permits publication of notices that direct investors to the funding portal or broker, and the SEC is likely to impose other rules regulating publicity surrounding the offering.
After the offering, the company must continue to provide follow-up reports to the SEC and investors. At a minimum, these will include financial statements and a description of recent operations and results.
Crowdfunding is an interesting concept that relaxes securities law requirements in exchange for strict limits on the amount that investors can put at risk in the company. It remains to be seen whether the SEC will provide relatively simple guidelines allowing companies to conduct crowdfunding offerings at low cost, or whether the required disclosure materials and reports will be so detailed as to require extensive input from lawyers and accountants. The SEC faces a difficult task in striking a balance between two competing goals of the legislation: (a) making it easier for companies to raise capital, while (b) protecting investors from unscrupulous or incompetent promoters.
Will crowdfunding be right for your company?
Here are some factors that might give your company a leg up to pursue crowdfunding:
Here are some factors that might suggest crowdfunding is not right for you: