Franchise Crowdfunding

To Crowdfund or Not to Crowdfund, That is the Question

Not long after the internet became a widespread tool, small businesses started eying it as a way to raise capital from the general public without running afoul of state and federal securities laws. Crowdfunding was a possible route, but companies often couldn’t issue equity in their company when seeking funds from the general public. A possible solution came in 2012 when the Jumpstarting Our Business Startups or JOBS Act was passed.

More specifically, Title III of the JOBS Act allows for a ‘crowdfunding’ exception to securities laws that would otherwise require investors to be ​accredited investors​. Maybe we should actually back up for a second before we get to these exemptions.

After the stock market crash of 1929 and The Great Depression, the Securities Act was passed. It meant to protect against fraud by placing certain requirements on the issuance of a security unless an exemption applies. Of course, things like the internet and crowdfunding didn’t exist in the 1930s, so there was no exemption for small businesses to seize upon. Title III of the JOBS Act creates such an exemption for crowdfunding.

Regulation Crowdfunding

Raising capital and issuing securities in this way is known as ​Regulation Crowdfunding​. This means of issuing securities bypasses the need to have accredited investors and, subject to some limitations, the need for determinations based on income or net worth. Regulation crowdfunding can work kind of like the GoFundMe or Kickstarter campaigns you’ve probably seen going viral on social media, except instead of those sites, issuers use third-party intermediaries that have registered with the Securities and Exchange Commission, or SEC, to make their offering.

The main aspects of Regulation Crowdfunding touch on five main areas of concern:

• The exemption’s actual requirements,

• The requirements surrounding the issuers of securities in a crowdfunding

  placement,

• The requirements that apply to the intermediaries that are used in crowdfunding

  offerings,

• Some additional funding portal requirements, and

• Other miscellaneous provisions.

  There are also some limitations that have been placed on Regulation Crowdfunding. Some of the limitations mentioned above include limitations on how much can be invested in each 12-month period, as well as restrictions on reselling the security within a one year period. For example, in a 12-month period, the total amount of securities issued to an individual investor cannot exceed $100,000. This is in addition to the following limitations based on an individual’s annual income and net worth.

• If an individual’s annual income ​or n​ et worth is less than $100,000, the limit is $2,000 OR 5 percent of the lesser of either his or her annual income or net worth, whichever is greater;

• If both the annual income and net worth are equal to or greater than $100,000, then the limit is 10 percent of the lesser of either his or her annual income or his or her net worth.

  As mentioned above, another limitation on Regulation Crowdfunding is that securities must be sold through a funding ‘portal’ or through a broker-dealer that is registered with the SEC. The purpose of this requirement is to offer some protection to investors investing through crowdfunding. However, issuers should know the limitations regarding what funding portals can offer. For example, a funding portal cannot offer investment advice. Issuers can find a funding portal by visiting the website of the Financial Industry Regulatory Authority, also known as FINRA.2

  Another requirement related to Regulation Crowdfunding is the inclusion of Bad-Actor provisions, which means that if a covered person, such as the issuer or a director of the company or equity owner, had criminal convictions or other disciplinary action against him, something that is known as a ‘qualifying event,’ then the issuance of the securities would not be allowed. These disqualifications however will not look back at actions before May 16, 2016, when the Regulation Crowdfunding provisions went into effect.

  Lastly, the requirements include certain disclosures that must be made. While the Act itself is meant to reduce the regulatory burden on issuers, certain disclosures still exist, generally falling into one of five categories:

• Director and officer information;

• Principal shareholder information;

• The issuer’s business plans, including their risk factors;

• A description of the offering; and

• Financial disclosures

  Disclosures to the SEC and potential investors are made through ​Form C​, a 31 question form that must be filed with the SEC. However, it should be noted that the issuance of these securities must be made through a registered third-party, and this third party often can offer guidance about filling out and filing this form with the SEC. There are also ongoing reporting requirements that exist with regulation crowdfunding, such as annual reports that must be filed 120 days after the end of the issuer’s fiscal year.