In 2009, Sustainable Economies Law Center advisor Michael Shuman authored an article in the Community Development Investment Review, a publication of the Federal Reserve Bank of San Francisco. In the article, Michael pointed out that while locally owned, small businesses constitute about one-half of the private economy in terms of output and jobs, they receive almost no investment from the public.
“The regulations prohibit the average American from investing in any small business,” Michael argued. This is because in order to publicly advertise an investment opportunity, or even openly discuss interest in bringing on investors, a small business needs a permit from a state or federal regulatory agency, which entails a lengthy process, and most businesses that attempt to obtain such a permit typically spend tens of thousands of dollars to hire a lawyer. Since many businesses can’t afford this, they just don’t make investment opportunities available to their customers, friends, neighbors, or other community members. Michael pointed out that if you go to a casino, you’re not required to attest that you are an accredited gambler and read a thick disclosure document about the risks of gambling. Yet this is what is required for investing, which is arguably less risky than gambling!
So Michael made a modest proposal in the article: “One easy reform would be for the SEC to exempt from its usual expensive disclosure requirements any low-risk public ownership of locally owned microbusinesses. By low-risk, I mean that no person can hold more than $100 worth of any one stock—which means that we’re freeing up people to engage in the risk equivalent of a nice dinner for two. By local ownership, I mean that only residents within a state can buy, hold, and sell stock shares. And by microbusinesses, I mean any business with a total stock valuation on issuance of less than $250,000.”
In the summer of 2010, law student interns at the Sustainable Economies Law Center, with support from Paul Spinrad of Make magazine, worked on a petition to the SEC to request a rule change that would implement Michael’s proposal. Even though the SEC did not respond, news of this simple request spread. It seemed like a no-brainer—exempt $100 investments from the extremely onerous registration requirements. Amazingly, members of Congress and the President eventually expressed support for the idea of an exemption for small investments. This culminated in the passage of the CROWDFUND Act 1 (part of the JOBS Act, which includes several securities law reforms) on April 5, 2012.
The Crowdfunding Title of the JOBS Act, also known as the Crowdfund Act
The Crowdfunding Title of the JOBS Act, which finally went into effect in January, 2016, after numerous delays in the SELC rulemaking process, allows organizations to raise capital from the public using an SEC-registered crowdfunding intermediary. The maximum amount that can be raised is $1 million, and each non-accredited investor will be able to invest $2,000 or up to five percent of his or her annual income or net worth, whichever is greater. There is not limit to how much accredited investors can invest.
The intermediaries will have to meet several requirements including:
- Provide disclosures related to risks and other investor education materials;
- Ensure that each investor—
- Reviews investor-education information;
- Positively affirms that he/she understands that he/she is risking the loss of the entire investment, and that he/she could bear such a loss; and
- Answers questions demonstrating an understanding of the level of risk generally applicable to investments in start-ups, emerging businesses, and small issuers and an understanding of the risk of illiquidity;
- Take measures to reduce the risk of fraud, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of the issuer;
- Ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount;
- Make efforts to ensure that no investor in a 12-month period has purchased securities offered pursuant to the crowdfunding exemption that, in the aggregate, from all issuers, exceed the investment limits of the exemption.
The intermediary will have to provide the following information:
- The name, legal status, physical address, and website address of the issuer;
- The names of the directors and officers (and any persons occupying a similar status or performing a similar function), and each person holding more than 20 percent of the shares of the issuer;
- A description of the business of the issuer and the anticipated business plan of the issuer;
- A description of the financial condition of the issuer, including, for offerings that, together with all other offerings of the issuer under the crowdfunding exemption within the preceding 12-month period, have, in the aggregate, target offering amounts of
- $100,000 or less—the income tax returns filed by the issuer for the most recently completed year (if any) and financial statements of the issuer, which shall be certified by the principal executive officer of the issuer to be true and complete in all material respects;
- More than $100,000, but not more than $500,000—financial statements reviewed by a public accountant who is independent of the issuer, using professional standards and procedures for such review or standards and procedures established by the SEC, by rule, for such purpose; and
- More than $500,000 —audited financial statements;
- A description of the stated purpose and intended use of the proceeds;
- The target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target offering amount;
- The price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities;
- A description of the ownership and capital structure of the issuer, including:
- Terms of the securities of the issuer being offered and each other class of security of the issuer, including how such terms may be modified, and a summary of the differences between such securities, including how the rights of the securities being offered may be materially limited, diluted, or qualified by the rights of any other class of security of the issuer;
- A description of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers of the securities being offered;
- The name and ownership level of each existing shareholder who owns more than 20 percent of any class of the securities of the issuer;
- How the securities being offered are being valued, and examples of methods for how such securities may be valued by the issuer in the future, including during subsequent corporate actions; and
- The risks to purchasers of the securities relating to minority ownership in the issuer, the risks associated with corporate actions, including additional issuances of shares, a sale of the issuer or of assets of the issuer, or transactions with related parties.
The issuer may not advertise the terms of the offering, except for notices that simply state that the issuer is conducting a public offering and that direct investors to the intermediary’s website. No other advertising of the offering outside the web platform is allowed. The issuer will also be required to provide regular reports to the SEC and investors.
There are two other provisions of the CROWDFUND Act that will make it much easier to raise money from a large number of small investors around the nation:
- Offerings under the CROWDFUND Act are exempt from the requirement that a company with more than 500 investors in a single equity class that has $10 million in assets automatically becomes a public reporting company (the SEC may impose conditions on this exemption in its rulemaking process).
- The states are not allowed to require registration of offerings that are exempt under the CROWDFUND Act (however, they can require notice filings and fees in the state that is the issuer’s principal place of business and in any state in which purchasers of 50 percent or greater of the aggregate amount of the issue are residents).
Finally, the legislation requires that dollar amounts under the exemption will be adjusted not less frequently than once every five years to reflect any change in the Consumer Price Index.
The Sustainable Economies Law Center has provided opinions on the viability of this new law compared to state-level crowdfunding laws on its blog here.
- H.R. 3606, 112th Cong. (2012). ↩