Collecting small sums of money from the
general public over the Internet is not a new phenomenon. But using that money
in return for an equity interest in a business has historically been prohibited
under U.S. securities law. Crowdfunding, as the term has become known, is currently
on Congress's radar, as bills in both the House and Senate make their way to
the president's desk for likely approval. While the legislative process has
come to a halt in many areas, the "Crowdfunding" bills are proceeding
and have received overwhelming support from both parties.
Generally, equity interests in businesses in
return for a capital investment to help businesses operate and grow are
registerable under the Securities Act of 1933 ("1933 Act"), unless
the security or the transaction is exempt. Crowdfunding, by its definition,
does not fall within the current exemptions available under the 1933 Act. The
main obstacle is that the offer to invest cannot be circulated to the general
public; it must be offered only to a select group of potential sophisticated
investors. When a company uses a website, however, anyone with Internet access
would have the opportunity to invest.
On November 3, the House of Representatives
passed bills H.R 2930 (Entrepreneur Access to Capital Act) and H.R. 2940 (Access
to Capital for Job Creators Act). H.R. 2930, also called the
"Crowdfunding" bill, proposes an amendment to the 1933 Act, adding
two new sections that would exempt transactions from the registration
requirements where the aggregate amount of securities sold by an issuer in a
12-month period does not exceed (a) $1,000,000 or (b) $2,000,000, if the issuer
provides potential investors with audited financial statements. H.R. 2940
proposes amending the prohibition against general solicitations or general advertising,
so that more sales would be permitted.
In the Senate, Republican Sen. Scott Brown of
Massachusetts introduced bill S. 1791 (Democratizing Access to Capital Act),
which although quite similar to H.R. 2930, did have some differences; most notably,
this bill would limit the investment amount to $1000 per person per year. There
are also some other proposals under S. 1791 to ensure that the states play a
larger regulatory role in monitoring Crowdfunding transactions. How that will
play out remains to be seen, but given that some states have already taken
action against websites operating in this sphere, it is likely they will take
on this responsibility with an eye toward generating additional revenue.
While we see the legislation as having the
potential to be extremely useful to both businesses and investors, companies
that are closely held must be vigilant. New investors, as minority
shareholders, will be entitled to certain rights, and may, depending on their
numbers, be able to block certain actions that a company wishes to make. The
company that fails to have two classes of stock/membership interest will surely
rue the day they opened their virtual doors to raise capital.
If you would like more information about
Crowdfunding, as either an investor or a company, please contact Darren
L. Braham, the author of this alert. You can reach Darren at 617 456
8014 or dbraham@PrinceLobel.com. If you would like more information about the firm's Corporate Practice Group, please contact Group Chair Robert P. Maloney at 617 456 8008 or rmaloney@PrinceLobel.com.