Crowdfunding for equity is one of those ideas that appeals to a lot of people. It has “crowd” appeal, you could say. Why not allow a great number of individuals (thousands) to each invest a little bit of money to fund projects that would otherwise not get funded? Especially projects like rooftop solar projects or similar ventures which improve society as a whole? Isn’t this a great idea?
Kickstarter now raises more money for the arts than the National Endowment for the Arts. Clearly, crowdfunding is the future we have all been waiting to be evenly distributed. (As William Gibson famously said, “The future is here, it’s just not evenly distributed yet.”)
But hold on a minute. We have a little snag we have to deal with first. That snag being state and federal securities laws. These laws were put in place in the aftermath of the stock market crashes that preceded the Great Depression, and strictly regulate the business of selling securities. These laws prohibit the crowdfunding future we thought was just about to be evenly distributed. Under these laws you can’t sell even $10 worth of securities without first going through an expensive process with state and federal regulators. There is no “de minimis” exception to the securities laws.
Under state and federal law, before you can sell any security, you must first either register the security with the securities regulators (which costs a ton) or find an exemption under which the security can be sold without registration. Most private company stock offerings proceed according to an exemption simply because the cost of registration is so great.
The problem for our crowdfunding future? Exemptions are limited in number and are typically subject to a number of conditions and limitations. There is currently in place no “crowdfunding” exemption.
Take my example, the company that wants to sell equity to build a rooftop solar or wind project by selling shares at the local coffee shop (just drop that $100 off while you pay for your coffee). The company would find it very hard (impossible actually) to find a securities law exemption that would allow it to proceed in the manner described.
The JOBS Act crowdfunding provisions are supposed to resolve the above dilemma, and allow ordinary Americans to invest. (By the way, right now ordinary Americans are cut out of the private securities market almost entirely because almost all private securities offerings are “accredited investor” only offerings. Accredited investors are generally individuals with a $1M net worth, excluding their home equity, or incomes of at least $200,000 a year for the last 2 years with the expectation of the same in the year of investment, or $300,000 with their spouses.)
The trouble? The very concept of crowdfunding is at odds with the structure of the federal securities law. The most commonly used federal securities law exemption, Rule 506, is a safe harbor under Section 4(a)(2) of the Securities Act. Section 4(a)(2) exempts “transactions by an issuer not involving any public offering.”
How can crowdfunding be reconciled with this very fundamental no-public-offering concept that has been a part of the securities laws since the 1930s?
Aren’t companies that are crowdfunding going to be able to generally advertise that they are raising money? The answer, oddly enough, is no. All companies are going to be able to do under a crowdfunding offering is give “notices which direct investors to the funding portal or broker.” The JOBS Act specifically disallows issuers of crowdfunding offerings from advertising: “an issuer who offers or sells securities shall . . . not advertise the terms of the offering, except for notices which direct investors to the funding or portal.”
If issuer can’t generally solicit, is it still crowdfunding? Well, it is still crowdfunding, at least according to the JOBS Act.
Contrast this with Section II of the JOBS Act. Under Title II, issuers in all accredited offerings are going to be able to put up billboards along the highway if they want, advertising “Buy Our Stock!” But that is for a different blog post.