CROWDFUND Act Brings Big Changes to Start-Up Investing

By Ralph Kokka

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A new investment law could revolutionize capital fundraising or become a new vehicle for fraud. The jury is still out. A few months ago, President Obama signed the JOBS Act into law. One of the key sections of the JOBS Act is the CROWDFUND Act, which will make substantial changes to how private businesses can raise money. Under previous SEC rules, a private company was basically limited to seeking investments from accredited investors (i.e., investors with a net worth of $1,000,0000 or annual income in excess of $200,000 for the past two years). These rules limited companies to seeking money from wealthy investors or funds such as angel investors or venture funds.

The CROWDFUND Act democratizes the fund raising process by enabling a company to seek investments from just about anyone, subject to certain limitations. Under the CROWDFUND Act, companies can raise up to $1,000,000 during any 12 month period from crowdfunded investors. Investors who make less than $100,000 per year can invest up to the greater of 5% of annual income or $2,000 in a single company. Investors who make more than $100,000 can invest up to 10% of their annual income or net worth in a company.

Crowdfunded investments are required to be conducted through an intermediary, such as the current websites, Launcht and Kickstarter. Presumably, others will join the fray. Intermediaries must register with the SEC as either a broker or funding portal. The regulations for funding portals is lighter because funding portals agree not to solicit purchases, offer investment advice or handle investor funds. Companies are required to disclose certain basic information to crowdfunded investors, including CPA reviewed financial statements for offerings between $100,000 and $500,000 and audited financials for offerings between $500,000 and $1,000,000.

Presently, the CROWDFUND Act is being reviewed by the SEC as part of its rulemaking process, which is expected to be completed by the end of the year. The CROWDFUND Act’s lower income thresholds for investors and its streamlined disclosure requirements could revolutionize the capital raising process for small companies. At the same time, however, these same features could make it easier for scammers and frauds to prey upon the unsophisticated investor. Whether the CROWDFUND Act is an investment boon or bane remains to be seen.

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Ralph Kokka, an attorney with Patton & Sullivan, specializes in business law and estate planning. For questions or comments he can be reached at ralph@pattonsullivan.com.

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