NY Startup Law

A businesslaw blog for New York entrepreneurs by Marc Law Associates PLLC

4 RULES YOU SHOULD BE AWARE OF IF PLANNING TO RAISE MONEY THROUGH CROWDFUNDING

In May 2012, Congress ratified a bill to expand crowdfunding as a method of  raising capital for small companies. Prior to the enactment of this bill, investors participating in the crowd funding process were allowed to invest capital in return for a small gift from the issuer. In hopes of enlarging the availability of funding for the entrepreneur, this bill expanded the crowdfunding to allow investors in these companies to receive equity in exchange for their investment.

The purpose of the bill is to provide companies that raise crowdfunded capital with certain exemptions in the Securities Act of 1933 under strict rules. Among these rules uare:

  • any crowdfunded startup can raise up to one million dollars a year
  • No crowfunded startup can solicit more than $2,0000 a year or 5% of an investors annual income from investors whose annual income or net worth is less than $100,000.
  • Startups raising money this way can solicit up to 10% of the annual income or net worth of investors whose annual income or net worth is over $100,000
  • A broker or online funding portal that is registered with the SEC as such, must be the intermediary between the startup and investors in the investment process.
The bill outlines strict guidelines for startups raising money through crowdfunding. If you are one of these companies you must file your company information with the SEC and to all portal users. If your goal is to raise less than $100K you must file the company’s latest income tax statement. You must file financial statements certified by a CPA if raising between $100,000 and $500,000. If you want to raise more than $500,000 you will need to file audited financial statements. Other requirements are capital structure and the difference in rights of any different classes of stock if your company is structure as such, disclosure of the risks of minority ownership, and your method of valuating your price per share. 
The brokers or funding portals also have to follow guidelines with respect to the offering. Some of these include providing certain disclosures to investors as well as ensuring that the investors have a clear understanding of the possibility of the risk of losing their entire investment, and have a clear understanding of risk in general and the concept of liquidity. In addition, brokers may only distribute funds after reaching the startup’s  total stated desired amount, and is strictly prohibited from paying anyone for soliciting investors for the offering. 
This is only the beginning and I’m sure we will see more changes as the bill is formally implemented. Critics of the bill say that it leaves more room for fraudulent behavior at the risk of the small investor. Proponents point to the possibility of leveling the playing field for raising capital between small companies and the companies that seek public investors. I personally am going to wait to see how this practice works in the real world until voicing a formal opinion on the matter. Hopefully, though this bill will have the desired effect of those who passed it.
Patrick Marc, Esq.

 

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