The U.S. Securities and Exchange Commission is meeting to consider a proposal that would allow businesses to sell ownership stakes in their companies by soliciting investors over the Internet.
The SEC plan being discussed in Washington today would create rules for equity crowdfunding, which lawmakers intended to ease financing for startups and small companies when they authorized it in the 2012 Jumpstart Our Business Startups Act. The rules may give a boost to the nascent crowdfunding industry as they show the agency’s progress in advancing a backlog of regulations required under the JOBS Act and Dodd-Frank law.
Businesses and startups too small or risky to attract funding from banks or venture capitalists are expected to use equity crowdfunding. Its success may turn on whether the rules make crowdfunding an attractive way to seek money from investors, said Rory Eakin, chief operating officer of CircleUp Network Inc.
“If they craft rules that are too onerous on the businesses, they won’t get the best companies and that will make it more difficult for investors to find returns,” said Eakin, whose company operates a funding portal that connects companies with accredited investors. “It’s not an easy task, and it’s not surprising to me it has taken some time because they are difficult rules to write.”
The SEC’s proposal, overdue by nine months, will become the second regulation from the JOBS Act advanced under Chairman Mary Jo White. In July the agency approved a rule that lifted the ban on advertising for investors outside of a public offering, which eased the ability to market directly to accredited investors, or those considered sophisticated and wealthy enough to understand the risks of investing and withstand a loss.
Crowdfunding will be open to any investor regardless of their income or net worth. Eight U.S. senators on Oct. 21. called for White to release the proposal, saying entrepreneurs and companies that created funding platforms have been hurt by the delay.
Under the law, businesses using crowdfunding could raise no more than $5,000 a year from someone whose net worth is less than $100,000. Investors with a net worth greater than $100,000 could contribute as much as 10 percent of their annual income or net worth, up to a maximum of $100,000 in one year.
The proposal won’t require businesses using crowdfunding to verify compliance with those restrictions, according to two people with direct knowledge of the matter who asked not to be identified because the proposal wasn’t yet public.
A person investing in a project through a crowdfunding portal will have to disclose their income or net worth, said Sherwood Neiss, principal at consultant Crowdfund Capital Advisors. The systems will block an investment that exceeds the income and wealth thresholds, he said.
“The most important thing in my mind is ensuring there is robust education to inform potential investors these are high- risk, illiquid investments that are not suitable for all investors,” Eakin said in a phone interview.
The proposal will require crowdfunding portals to provide investors with educational materials and forums to enable communication about offerings, according to a fact sheet released today by the SEC.
A company using equity crowdfunding is limited to raising a maximum of $1 million per year. Even small companies that use equity crowdfunding will have to, depending on their size, disclose their income-tax returns or financial statements and annual operating results. A company seeking to raise more than $500,000 must provide audited financial statements.
If approved by the commission’s five members, the proposal will be open to public comment for 90 days before the SEC can vote on a final version. The Financial Industry Regulatory Authority will propose detailed rules for funding portals that don’t register as brokerages.