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Crowdfunding Legislation

In the past several years, banks have been reluctant to loan money to start-up businesses, including start-up breweries. If the bank and your rich uncle will not fund your venture, can you ask people to invest in your company?

n the US, the answer is yes, but...the Securities and Exchange Commission (SEC) heavily regulates the transfer of securities, which makes it difficult for small businesses to raise capital while trying to comply with the SEC rules and regulations. These regulations do not allow you to advertise for investors without being registered with a stock exchange. There are exemptions, but there are also many rules and none of them allow you to “advertise” to people you do not already know you want to invest in your brewery.

Now that the Jumpstart Our Business Startups (JOBS) Act has passed, many people are jumping to try to get into the crowdfunding game. Crowdfunding will allow you to solicit for investors in your brewery. However, the Act put into place many limitations and obligations for people assisting in the sale (intermediaries) of equity in a company and the companies themselves. These limitations and obligations, while intended to protect the small investor, may drive up the cost of trying to access this capital.

The Act requires an intermediary to be involved to separate the direct solicitation between a company trying to raise money and the potential investors. The SEC has warned that the Act requires intermediaries to follow specific obligations and rules that the SEC has been given the power to determine. The SEC has stated on their website that intermediaries are required to do, among other things, the following:

  • Provide disclosures that the SEC may determine are appropriate which will include providing financial disclosure information to potential investors.

  • Make available disclosures provided by the issuer to investors and the SEC, at least 21 days before any sale.

  • Take measures to ensure that no investor in a 12-month period has purchased crowdfunded securities that, in the aggregate, from all issuers, exceed the investment limits set forth in section Title III of the JOBS Act.

  • Must ensure that each investor: (1) reviews investor education materials; (2) positively affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and (3) answer questions that demonstrate that the investor understands the level of risk generally applicable to investments in startups, emerging businesses, and small issuers and the risk of illiquidity.

  • Must take steps to protect the privacy of information collected from investors.

  • Take such measures to reduce the risk of fraud with respect to such transactions as established by the SEC rules, 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 every issuer whose securities are offered by such person.

  • 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, and allow all investors to cancel their commitments to invest.

  • Any other requirements that the SEC determines are appropriate.

Although the obligations and limitations described above are directed at the intermediary, those trying to raise money will need to supply the information and disclosure documents in order for the intermediary to comply with the SEC rules. The more detailed the disclosure documents need to be, the more costly they will be to generate.

The exemption for crowdfunding will not be available until 2013. As you can see, many of the rules above are described generally and have not yet been determined. The SEC continues to issue answers to questions and it is aware that many websites are trying to jump into the crowdfunding arena early. It has started to give public warnings about the availability of crowdfunding and the requirements involved in these transactions to notify the public to be wary of any website that purports to be an intermediary dealing in securities.

The SEC has issued the first set of proposed rules, but only as it relates to accredited investors, which are generally individuals with a net worth exceeding $1 million or an individual who has income in excess of $200,000 in each of the two most recent tax year. However, the excitement surrounding the JOBS Act is that crowdfunding will be open to non-accredited investors, but the SEC has yet to issue any specific rules on how non-accredited crowdfunding will work. As for accredited investors, the seller of the securities (i.e. broker or intermediary) must verify the accreditation of the investor. This will likely slow the process of raising money, and is probably not what most start-ups were hoping to see.

Once the exemption is available, and even if the regulations slow the process a bit, it will still be a good alternative for raising money on a mass scale. However, intermediaries and companies should be aware that there will still be many documents and disclosures required before they can access the crowd. Questions about crowdfunding? Contact Jeff Jacobson at 231.722.5405.

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