What North Carolina Small Businesses Need to Know About Equity Crowdfunding: Part II

Date: August 19, 2015

Equity crowdfunding could be more beneficial for small business owners than more traditional online platforms like Kickstarter and Indiegogo.

As more and more states are moving crowdfunding bills through their legislatures, small business owners and new business owners should start familiarizing themselves with the different types of crowdfunding methods—and how these channels can help them. Or can they?

Kickstarter is one of the most well-known and popular venues for crowdfunding. The latest king of this site is a company called Pebble, which was able to raise more than $20 million from nearly 80,000 people in its second try on Kickstarter. The company sells a smartwatch that has a seven-day battery and a new timeline interface to rival Apple.

This is the type of crowdfunding that gets big news and excites every entrepreneur who is ready to hit the internet with their latest product. And yet, it’s not the kind of crowdfunding that involves investors. It’s a strategy that doesn’t require much more than an interesting marketing page for donators to view on a website, and not all businesses will meet their goals this way. There are a few breakout stars like Pebble, but for some businesses and investors, there’s more to gain from equity crowdfunding.

Equity Crowdfunding

President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law in 2012, promising that small and emerging companies would be able to raise the capital they needed through equity crowdfunding. Parts of the law would provide startups, a group that typically faces significant fundraising obstacles, access to a wider range of capital opportunities.

Unlike platforms like Kickstarter and Indiegogo, where companies simply ask for donations to fulfill their product or service goals, equity crowdfunding gives investors a piece of the business. People who donate money on Kickstarter don’t become shareholders or part owners. Instead, they give money to a company and might receive something in return, such as a product, but not ownership.

“It’s an interesting way to get company up and running,” says Braden Perry, partner in the Kansas City-based law firm Kennyhertz Perry and a former federal enforcement attorney and veteran in government compliance. “Normally, it’s the startups that need the capital the most.”

The JOBS Act required the Securities and Exchange Commission to issue an entirely new set of recommendations to ensure participation in equity crowdfunding was lawful, fair and transparent. Strict rules are in place for other methods of investing, that require businesses to perform valuations, register with the SEC and provide extensive financial records and reports.

“The JOBS Act is interesting in that it’s still a work in progress,” says Perry. “There’s going to be changes to the JOBS Act as it plays out in practice. Right now, there’s a question and many people do have a concern over the level of information needed to provide to investors.”

The most crucial part of creating new regulations for equity crowdfunding is ensuring businesses provide substantial financial records, checks and valuations. Without a regulated infrastructure, investors are unlikely to get in on the ground floor of an up-and-coming company, and many are likely to get duped.

Three years after the JOBS Act was signed, only one part of the rules has been finalized as the SEC continues to weigh these risks.

Where Crowdfunding is Already Happening

While the SEC continues to debate and finalize its recommendations under the JOBS Act, states have begun issuing their own rules to accommodate small businesses and investors eager to jump on online platforms.

Twenty-one states and the District of Columbia have intrastate crowdfunding laws in place, and many more states are considering bills to make the practice lawful, according to the North American Securities Administrators Association.

However, for many states that have approved exemptions for intrastate investment crowdfunding, there are significant limitations for fundraising. In Michigan, small businesses and startups can raise money by selling securities to investors over a 12-month period, but cannot raise more than $2 million and must provide audited financial records. Unaccredited investors can participate, but cannot invest more than $10,000. There is no restriction for accredited investors under these rules.

Intrastate crowdfunding laws can give businesses immediate access to more investors, but business owners are limited to raise money in that state only. Companies that participate in intrastate crowdfunding may run into some issues if business owners hope to raise higher amounts.

“The way the federal law works is that if you have a company and you want to raise money in North Carolina, it has to be in North Carolina stock-filed company,” explains DJ Paul, a member of the SEC advisory committee and co-chair of the Crowdfund Intermediary Regulatory Advocates. “You’re restricted to raising through North Carolina investors, however they define their investors.”

Intrastate exemptions are a short-term solution, and there seems to be no rush to make the practice uniform as states wait for all the SEC’s rulings and recommendations.

“I don’t think that anyone feels any urgency to make them coordinated on a state-by-state basis,” says Paul. “There’s no real value in it except for some continuity. As a practical matter, an intrastate law in a particular state can only be useful for a company that’s founded there and can only raise money from citizens who are solvent there as well.“

As the SEC continues to roll out the rest of its rulings on the JOBS Act, small business owners have a lot to look forward to in crowdfunding ventures.

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