Crowdfunding your startup II – what if Congress does not act?
In my last post, I reviewed the “crowdfunding” legislation that’s before Congress. Since that legislation may be stalled, I’d outline how a company might orchestrate a crowdfunding round in the absence of legislation.
For this discussion, a general familiarity with the laws and regulations governing private offerings is helpful. (You can read goodcounsel’s GoodGuide here.) The important thing to know is that you can’t offer securities to the public without registration (=time-consuming, expensive), unless you fall within a valid exemption.
The primary exemptions are for “private” offerings. What is “private” can be a bit subjective, which is why most companies and entrepreneurs try to stay within one of the “safe harbors” set out in Regulation D (“Reg. D”) of federal securities law. These safe harbors are not mandatory, but they offer clear standards and therefore a high degree of certainty that by meeting them, you’ll stay on friendly terms with the SEC (Securities & Exchange Commission).
So is there a way to crowdfund under current securities laws? Before answering that, we should define terms. Crowdfunding, in my view, is:
- An early-stage financing round of a limited dollar amount
- in which a large number of investors,
- including people the company has reached through general solicitations, such as social media (i.e., those with no preexisting relationship to the company),
- invest small amounts of money.
From a legal perspective, the major problem with crowdfunding is item 3. It’s hard to claim that your offering is not public when you are publicizing it to people you don’t even know. Most of the Regulation D safe harbors explicitly prohibit general advertising and solicitation. (That’s Rule 502.)
Rule 504, however, allows general solicitation under limited circumstances: where the offering takes place under a state securities law exemption (did I mention that you have to worry about state as well as federal securities laws?) that permits general solicitation, and then, only to accredited investors (i.e., people with lot of money). How many state securities laws allow general solicitation without registration? Darn few. Illinois doesn’t. Oh well.
But wait. Another section of Rule 504 permits general solicitations if the securities are registered in at least one state. Yes, we were trying mightily to avoid registration, but there is a simplified registration procedure for small companies, the Small Company Offering Registration, or “SCOR,” that has been adopted in most states. Simple, relatively speaking. SCOR registrations still have pages of requirements to understand and significant paperwork to file, state approval is required before you can proceed, and compliance obligations continue even after approval. (For example, Illinois rules can be found here.)
So to sum up, the answer is this:
You may be able to crowdfund a raise of up to $1,000,000, relying on federal Rule 504 and a SCOR filing in at least one state where the offering is taking place. Not a walk in the park, but certainly doable.
Is this worth it to crowdfund $1,000,000? It depends on your circumstances.
If you have a strong network or live in an active entrepreneurial community, you may be able to raise $1,000,000 from a small group of accredited investors – relying on Reg D safe harbors that don’t require any registration. (Not to minimize the challenges of that – even in a world more comfortable with startup risk.)
For true crowdfunding to be practical, it seems that we just have to hold our breath and see what Congress does.
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