On April 5, 2012, President Obama signed into law the Jumpstart our Business Startups (JOBS) Act. The Act provides for a new exemption from the SEC's requirement to register public offerings, possibly paving the way for startups to issue up to $1 million of securities to up to 2,000 public investors, via online funding portals. The exemption is not effective until the SEC has adopted rules permitting companies to offer and sell securities through crowdfunding.
Historically, crowdfunding has been used to request donations for disaster relief, art projects and social networking projects. Title III of the Act created an exemption that would allow a startup company to use this funding process to sell securities to investors. To date, rules have been proposed but not adopted. Until rules are adopted, the use of crowdfunding to sell securities is not legal.
Once effective, the crowdfunding exemption would allow a startup company to solicit investments, via an online crowdfunding portal, from the general public. Unaccredited investors will be subject to various limits on how much they can invest, and the companies will be subject to various reporting requirements. The company itself would not be allowed to advertise the terms of the offering, but would only be allowed to direct potential investors to an appropriate funding portal or broker.
Although we have no rules allowing the use of crowdfunding to sell securities, the SEC has adopted Rule 506(c) of Regulation D, which repeals the ban on general solicitation when only accredited investors are solicited. Therefore, a startup may solicit investors online, but must take steps to ensure all investors are accredited, which often is not feasible through a relationship that is entirely online. Once a business chooses to engage in such general solicitation, it may not accept funds from any non-accredited investor for that offering. An accredited investor is a natural person with earned income of greater than $200,000 (or $300,000 together with a spouse) in each of the prior two years who reasonably expects the same for the current year, or who has a net worth over $1 million, either together or with a spouse, excluding the person's primary residence.
Until the new crowdfunding rules are promulgated, startups should continue to keep a watchful eye on the SEC's developments and rely on currently available exemptions.