Crowdfunding began as an invitation over the Internet for small amounts of money from large numbers of persons to support a particular idea or product or event. Those responding received gratification and sometimes a product.
In the JOBS Act, Congress sought to extend crowdfunding to equity offerings. Article III of the JOBS Act created an exemption for crowdfunding offerings. The offerings had to be made by non-reporting companies and could not exceed $1 million in any 12 month period. The offerings were to be made through a broker or over an Internet portal. Investors were subject to caps on the amount they could invest; portals had to police for fraud and monitor the investment caps; and companies had to provide specified information about their business and their officers, directors and 20% shareholders.
Crowdfunding couldn't be implemented until the SEC adopted the necessary rules. The Act specified that the Commission should "issue such rules" as deemed appropriate within 270 days from enactment. The date of enactment was April 5, 2012. Issue presumably means "propose" rather than adopt. Proposals are, therefore, due right around the last day of the year.
Portals will also have to register with FINRA. FINRA will, therefore, have to draft rules that deal with the requirements for crowdfunding portals. FINRA has solicited comments on these requirements, requesting in particular comments on "possible rules concerning supervision, advertising, anti-money
laundering, fraud and manipulation, and just and equitable principles of trade." The comments are here. The JOBS Act placed no deadline on rules by FINRA.
Crowdfunding has advantages. It may provide funding to small businesses when banks won't lend. But it comes with considerable restrictions. Information about the business has to be posted. Officers, directors, and large shareholders are likely to be subjected to criminal background checks. Directors will have legal exposure for false disclosure. Moreover, small companies with many small investors will find the configuration a nuisance. There are disclosures that will be required under federal law and notices of meeting required under state law.
Crowdfunding may, therefore, turn out to be an avenue used as a last resort primarily by small companies unable to obtain bank loans. As the WSJ recently reported:
In a November survey of 740 small-business owners, with between $1 million and $20 million in annual revenue, only 21% said they were aware of the JOBS Act. Just 3% of small businesses said they felt they would benefit from equity crowdfunding, according to the survey, by The Wall Street Journal and Vistage International Inc., an executive advisory group. The downside of the strategy for business owners is likely to be the potential hassle of managing many investors, each with a small stake in the company.
Moreover, these offerings are mostly expected to take place over Internet sites set up for that purpose. In the beginning, however, there will likely be numerous sites. As the Journal noted: "Last month, there were 8,800 Web domain names registered in the U.S. and Canada using some form of the term "crowdfunding," up from 900 in January." With a large number of portals, at least initially, companies may attract less attention and have a harder time selling equity. In addition, portals will have to monitor the limits on individual investments, something that will be harder since investors can use multiple portals.
The rulemaking process with respect to crowdfunding will be tense. The fact that the offerings will be to unsophisticated investors in what will often be very high risk ventures suggests that there will be a need for significant investor protections. Yet these protections will impose costs on the offering process. We will have more to say about this exemption soon. In the end, the SEC may be able to draft rules that successfully protect investors without significantly burdening the capital raising process. But given the requirements of the Act, this may not be possible. For crowdfunding to achieve its potential, the Act itself may need to be amended.