How to Understand the New World of Crowdfunding

Crowdfunding presents a tremendous opportunity for private companies to raise capital by collecting small contributions from a large number of investors.

Although crowdfunding has been around in some shape or form for centuries – praenumeration is considered an early form of this business model – it has just started to become regulated. The SEC and FINRA recently issued proposed rules, but there are still unknowns as to how it will play out, and there will certainly be more debate and regulation to come.

1. Crowdfunding seems like a great way for entrepreneurs to fund new projects, but I would like more specifics about the law. What parts of the JOBS Act relate to crowdfunding?

The Jumpstart Our Business Startups (JOBS) Act addresses access to capital in a number of ways. Title II and Title III relate to crowdfunding.

The regulations on Title II have been finalized and released. Title II of the JOBS Act lifts an 80-year-old ban on public solicitation for private offerings exempt from securities registration. In short, it allows private companies to publicly solicit and advertise to potential investors. This means private equity funds can now promote offerings on Twitter, LinkedIn, Facebook and other mainstream channels as long as these communities lead back to a platform that verifies accredited investors.

There are approximately 8 million accredited investors, but only about 375,000 currently invest in private equity. The ability to advertise to these accredited investors opens a tremendous opportunity for funding for the private sector, which provides funding portal platform technology and market data solutions to the private equity and crowdfunding securities industry.

2. Who is considered an “accredited investor” under the JOBS Act?

An accredited investor is one who earned more than $200,000 (single) or $300,000 (joint) per year for the previous two years and is expected to maintain this level of income in the current year; or an individual or couple with a net worth in excess of $1 million (excluding their primary residence); or a general partner, executive officer, director or a related combination thereof for the issuer of a security being offered.

Private companies, including private equity firms and hedge funds, can now advertise everywhere but can only take money from accredited investors or qualified institutions. And each private equity firm needs to take reasonable steps to determine that the investor is accredited.

This requirement has created new companies that are in the business of verifying the accredited investors. Additionally, CPAs and financial brokers may be asked to assist in verifying this information.

3. What if you’re not an “accredited investor”?

Title III would open the door to the general public by enabling companies to raise up to $1 million per year through broker-dealer or funding portal websites such as Kickstarter.

The proposed rules include limits on the amount that non-accredited investors can invest, based on annual income or net worth. For example, someone earning less than $100,000 a year could invest only 5 percent of his income, or $2,000, whichever is greater.

The proposed SEC regulations on Title III were issued for comment on October 23, 2013, and are expected to be finalized in early 2014. The current proposal doesn’t require private companies to verify the income levels of its crowd investors, however, this topic is up for discussion during the comment period.

4. Is crowdfunding safe for investors?

The rules would require crowdfunding brokers and portals to take measures to reduce the risk of fraud. They should adopt “know your client” policies, including anti-money laundering and customer identification policies.

Despite its many benefits, crowdfunding, like any other financial and securities transaction, is unfortunately fraught with risk and opportunities for individuals to be taken advantage of. On July 10, 2013, the SEC adopted amendments under Regulation D to the Dodd-Frank Act to add “bad actor” disqualifications requirements to SEC act of 1933. These requirements will prohibit “bad actors” from issuing securities, regardless of whether they are available under crowdfunding.

Lisa Kahn Grossman is an associate principal in the Entrepreneurial Services department of Kaufman Rossin. She works with entrepreneurs, high-net worth individuals, and nonprofits. She is a certified QuickBooks ProAdvisor, a licensed Certified Public Accountant in the State of Florida, and a member of both the American Institute of Certified Public Accountants and Florida Institute of Certified Public Accountants.

Read about this crowdfunding article at bizjournals.com/philadelphia.