JOBS Act Crowdfunding Goes Into Effect

May 18, 2016

pic-moneyRecently, several key actions have been taken that would improve the access and affordability of crowdfunding options for small firms, including: the implementation of new regulations  from the Securities and Exchange Commission (SEC); a new report from the U.S. Small Business Administration (SBA) Office of Advocacy; and the introduction of legislation that would clarify that crowdfunding shareholders do not count toward an S-Corporation’s (S-Corps) cap on shareholders.

Crowdfunding Regulations Active

On May 16, Title III provisions of the Jumpstart Our Business Startups (JOBS) Act of 2012 authorizing equity crowdfunding went into effect. The regulations were supposed to be finalized by the SEC in 2012; however they were only finalized in October 2015.

The regulations will allow small businesses to raise up to $1 million per year, through intermediaries facilitating crowdfunding transactions. The regulations create a framework both for the companies seeking to make an offering and the intermediary through which the offering ultimately will be made.

Company disclosure requirements vary depending on the size of the offering. While the new rules do allow average Americans to engage in the crowdfunding, they will not have unfettered access. According to the regulations, an individual investor may not contribute more than $100,000 in any 12 month period across all crowdfunding offerings. However, the vast majority of Americans will face limits much lower than that, largely dependent upon their income and assets.

Under the regulations, all crowdfunding transactions would need to take place through an “SEC-registered intermediary,” a broker-dealer or a funding portal. These intermediaries will be required to provide information to potential investors, take measures to reduce the risk of fraud, develop systems to ensure investors are not investing more than they are allowed to and create systems to ensure that offering companies are complying with all relevant regulations. Furthermore, for a company to even make an offering through one of these intermediaries it must first comply with several provisions in the final rules. In an effort to provide purchasers with information to make informed purchases, companies are required to disclose financial statements, target information about the offering, and information about what the business plans to do with funds raised from the offering.

The next few months will provide insight into whether the final regulations strike an appropriate balance between consumer protection and financial incentive for all parties involved. It is critical that this balance ultimately be struck to allow crowdfunding to become a viable avenue of raising capital.

Office of Advocacy Report on Crowdfunding

On May 11, the SBA Office of Advocacy released a report on the current state of crowdfunding in the U.S. The report focuses not just on the impact of a crowdfunding campaign itself, but also on if a successful crowdfunding campaign can be used as a predictor of continued access to capital. The report used data on entrepreneurs who launched crowdfunding campaigns—from 2009 to 2012–to fund their startups in order to determine how crowdfunding impacted their businesses once the crowdfunding was complete.

The report found that a successful crowdfunding campaign often serves as a “proof of concept” of sorts which demonstrates to potential investors that the business idea is viable. However, this is most true for smaller offerings, usually less than $75,000. Importantly, the study concludes that crowdfunding does have a causal relationship with an individual’s ability to obtain outside financing following the crowdfunding campaign. This is in large part because, the report also found that a strong crowdfunding performance can increase the probability of business partnerships, generate good publicity, define a strong customer base, and make it easier to find employees.

NSBA Supports S-Corp Reform Bill

On May 10, NSBA sent a letter to House Committee on Ways and Means Chairman Kevin Brady (R-Texas) and Ranking Member Sander Levin (D-Mich.) supporting H.R. 4831 and urging the committee approve the legislation. H.R. 4831 was introduced by Rep. French Hill (R-Ark.) and amends the tax code clarifying that crowdfunding shareholders do not count toward an S-Corporation’s (S-Corps) cap on shareholders. This is a significant issue because an enormous amount of small businesses are S-Corps, including approximately 40 percent of NSBA’s members, and currently crowdfunding is very restricted if not, impossible for them.

Currently, S-Corps are only allowed to have 100 shareholders. This presents a serious obstacle for S-Corps looking to crowdfund as those offerings are dependent on having many small purchasers, rather than a few larger purchasers. This means that a single crowdfunding offering could very easily eclipse 100 purchasers and result in too many shareholders. This issue is further compounded by the fact that a business may gain additional shareholders after the actual offering concludes through splitting up shares following the death or divorce of a purchaser.

H.R. 4831 would enable S-Corps to take full advantage of the provisions included in the JOBS Act and facilitate job creation, incentivize entrepreneurs and promote long-term economic growth. The legislation has not yet been considered by the full committee.

Crowdfunding presents a tremendous opportunity for the small-business community. However, there has been concerns that the amount of due diligence that will be required by the portals could make offerings, particularly smaller ones uneconomical. NSBA will continue to monitor the situation and how successful small businesses are in making offerings utilizing these regulations. There is tremendous potential for small businesses in crowdfunding, however NSBA encourages Congress to act quickly to ensure that crowdfunding is given every chance to succeed.