Equity Crowdfunding Rules: Legislation In Progress

The average person already has some familiarity with crowdfunding thanks to websites like Kickstarter. This and similar sites let individuals contribute relatively small amounts of money to help new businesses purchase the equipment they need to begin operating.

There aren’t many rules for Kickstarter crowdfunding. There are, however, a lot of equity crowdfunding rules. It’s important to have a basic grasp of crowdfunding law before getting involved in the industry. If equity crowdfunding regulations elude you, then you may find that it’s difficult to stay within the law.

Laws that Affect Crowdfunding

Forbes contributor Wil Schroter notes that the Jumpstart Our Business Startups Act (JOBS Act) contains several passages that affect crowdfunding law. The Securities and Exchange Commission (SEC) is charged with enforcing equity crowdfunding rules. The SEC is also in charge of regulating securities sales and other investment vehicles.

Currently, there are two sections of the JOBS Act that make equity crowdfunding legal.

Title I of the JOBS Act makes it easier for businesses to go public via an initial public offering (IPO). Title I also exempts some companies from disclosing information that has discouraged companies from going public in the last decade.

Title II of the JOBS Act streamlined communications by letting companies use general solicitation to attract investors. Before this regulation, business leaders often had to travel extensively to find accredited investors interested in their securities. It took long periods of networking to find the right investors. Title II, however, made it legal for companies to advertise on television, billboards, the Internet, and practically every other media platform. This puts companies in contact with potential investors who have relatively little money compared to accredited investors and institutional accredited investors.

Potential Laws That May Influence the Future of Crowdfunding

In June 2014, Slate reporter Jim Saksa noted that, while the JOBS Act gave the SEC 270 days to finalize the rules that would regulate crowdfunding, nothing had been solidified after 800 days. Despite passing the deadline long ago, businesses interested in equity crowdfunding still don’t know how the new rules could affect them. Saksa laments in his article that the proposed changes to equity crowdfunding would allow investors who do not have enough expertise to participate in the industry. He also worries that making it easier for everyday people to invest their money would do little more than separate people from their savings.

Not everyone shares this dour opinion. According to Entrepreneur contributor Kendall Almerico, some people see equity crowdfunding as an exciting way to revive the American Dream. By letting people purchase securities, hopeful entrepreneurs believe that they can give average people opportunities to generate money by investing a portion of their savings in securities. Regulation D currently defines accredited investors as those who have at least $1 million in assets, not including the value of their primary residences.

That’s much more than the average person has. Opening the door to crowdfunding could enable more people to benefit from the same opportunities that have helped generate more wealth for rich families.

Most people in the industry agree that enacting proposed laws would open a new source of capital that would benefit businesses and individual investors. Until Congress and the SEC can decide exactly how those laws will function, though, no one knows exactly what the industry will look like in a month, a year, or a decade. There is considerable hope, but also some hesitancy.

The most pressing laws under review include Titles III, IV, and V of the JOBS Act. Title III will let companies sell securities to non-accredited investors who have never had access to these opportunities. Title IV and V contain language that, if finalized, would address further initiatives that would make it easier for companies to raise capital through streamlined, more personalized processes.

When can investors and businesses expect a finalized set of rules? Probably not until Congress meets again after the holidays. Whether that happens, though, will likely depend on several factors, such as how mid-term election winners want to influence the economy and whether Congress gets stuck debating other issues.

Legislating and Regulating the Crowdfunding Industry

The SEC regulates the crowdfunding industry. It also regulates other areas of the investment industry. Congress, however, creates the laws that regulate investment.

Congress gives authority to the SEC to regulate the industry. It also recognizes that the SEC has authority and expertise that most agencies lack. The SEC, therefore, provides significant input to members of Congress developing new regulations. When the SEC reviews legislation, it can provide feedback that influences how Congress finalizes rules and what language lawmakers include.

Alternatives to Crowdfunding

Changes to crowdfunding regulations could inject money into developing businesses that need more capital to grow. The JOBS Act looks promising, but it’s difficult for anyone to know how the industry will change after all sections of the Act have been finalized. This uncertainty encourages some people to explore alternatives to crowdfunding.

There are several alternatives, and some are more popular than others. The options that match one business’s needs may not meet the needs of another. This makes it important for organizations to review their financial needs so they can make informed choices when soliciting money from investors.

Accredited Investors

Accredited investors are one of the most reliable options for businesses that want to raise capital by selling securities. According to Regulation D, an individual qualifies as an accredited investor if he or she:

  • Has earned at least $200,000 per year for the last two consecutive years.
  • Has a combined spousal income of at least $300,000 per year for the last two consecutive years
  • Has at least $1 million in assets, not including the value of the person’s primary residence.

There are several advantages to focusing on accredited investors. These investors have more money than the average person, so they can contribute more to the businesses that they believe will generate large profits. Businesses that sell securities exclusively to accredited investors may also be exempt from providing extensive information about the risks of buying securities and similar vehicles. Accredited investors are expected to know how to choose their investments carefully, so companies don’t need to reveal as much information when soliciting them.

Institutional Accredited Investors

Institutional accredited investors often have even more money to invest in growing businesses. Most institutional accredited investors must have at least $5 million in assets. They may also need an individual accredited investor who makes decisions for the institution. Since institutional accredited investors have access to large amounts of money, they can significantly influence which companies get the capital they need to grow and succeed.

Business Loans

Businesses that cannot raise equity by selling securities via crowdfunding, accredited investors, and institutional accredited investors may need to explore business loans that will give them access to the capital they need to grow. Loans, of course, come with interest rates. Companies must repay their loans plus interest. If the business’s plans work and it profits from the loan, then this is a good option. Unfortunately, businesses that don’t succeed may have difficulty repaying their loans.

Crowdfunding rules and legislation may have created uncertainty in the industry, but it’s still a useful option among several equity funding strategies.

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Comments (2)

According to me, a person with no expertise in crowdfunding shouldn’t be allowed to fund businesses as this could risk savings of the recipient resulting in losses.

That’s one of the primary reasons opponents have against opening equity crowdfunding to inexperienced investors. The majority of regulations regarding accredited investors are intended to protect individuals from losing their savings to risky or predatory investments, but is financial criteria alone enough to judge an investors ability to invest intelligently?

For example, many private equity professionals deal with these types of investments every day, yet don’t make enough to qualify as accredited investors. At the same time, there are trust-fund babies with no investing knowledge that the SEC has deemed perfectly capable of participating in these high-risk offerings due to their large assets.

The current system isn’t perfect, but will these changes improve it or cause more problems?

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