Eighteen months after the JOBS Act was signed into law, the idea of crowdfunding—where small companies can raise money from the general public over the Internet— is inching closer to reality.October 29, 2013
On Oct. 23, the SEC released its long-awaited proposed rules for Title III of the JOBS Act—aka the crowdfunding provision—with all six commissioners voting to approve them. The proposal kicks off a 90-day comment period, after which SEC staffers will consolidate the comments and decide whether to recommend changes to the rules.
Given that timetable, most observers predict that investment-style crowdfunding won't become a reality until mid-2014, at the earliest. But they were largely pleased with the progress and the way the rules were shaping up. "The overall rules are fair and balanced and live up to the spirit and intent of the legislation," said Sherwood Neiss, a principal with Crowdfund Capital Advisors who has been involved with the legislation from its inception.
At the open meeting, the SEC commissioners noted the historic significance of the rule changes—the most significant update to the nation's securities laws in eighty years—calling it a "bold step" with "great potential" to unlock capital for the nation's small businesses.
Until the Title III laws are officially approved, only wealthy, so-called "accredited" investors may invest in private companies via crowdfunding. (Securities laws only kick in when a financial return is promised, so the rules don't effect popular donation and reward-based crowdfunding sites like Kickstarter).
The broad outlines of crowdfunding remain as laid out in the JOBS Act:
- Companies can raise a maximum of $1 million through crowdfunding in a 12-month period
- Investors whose income and net worth are less than $100,000 are capped at $2,000 or 5% of their income, whichever is greater, in aggregate crowdfunding investments over a 12-month period
- Investors whose annual income or net worth is greater than $100,000 may invest up to 10% of their income or net worth, not to exceed $100,000 in a 12-month period
- All crowdfunding transactions must take place on an SEC-registered intermediary—either a broker-dealer or a crowdfunding portal
- The intermediaries must take measures to educate investors and mitigate fraud
- Companies raising money on these platforms must provide basic financial information (the proposed rules specify audited financials for offerings greater than $500,000)
The proposed rules and comment period are intended to resolve dozens of small details that, taken together, may determine the ultimate success or failure of crowdfunding—for example, how costly the process will be for small businesses seeking to raise money and for crowdfunding portals who hope to make a viable business in the new field.
As experts digest the nearly 600 pages of proposed rules, some interesting highlights have emerged. While much has been made about the $1 million cap for companies raising money through crowdfunding as a limiting factor, the SEC has indicated the cap would not include other capital raising efforts (for example, to accredited investors) as part of that threshold, effectively raising the amount companies can raise in a given year.
The rules also suggest that crowdfunding will be a costly endeavor not to be undertaken lightly. For instance, private companies raising money through Title III crowdfunding will be required to file annual reports with the SEC, much as public companies do. And for crowdfunding portals, the costs to register and comply with the rules will run into the hundreds of thousands of dollars. Further, there will be penalties for both issuing companies and crowdfunding platforms that run afoul of the rules. Indeed, says Neiss, the proposed rules will likely mean that entrepreneurs and crowdfunding portals will need compliance officers, and the filings and reporting requirements as proposed will increase the cost of raising capital through crowdfunding.
You can read the proposed rules here.
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