On April 5th, President Obama signed the CROWDFUND Act into law, allowing anyone - regardless of wealth - to invest at least $2000 into the startups they care about. Startups will be able to raise up to $1 million dollars from an unlimited number of investors, across all states. They'll also be able to advertise their fundraising efforts to the general public.
Unfortunately, the SEC will not implement the CROWDFUND Act until early 2013. So crowd investing - as described above - is still illegal.
How can Crowd Investing be Legal Now?
We've heard from a lot of startups that are excited to start raising capital from the crowd, today. So we met up with our very expensive lawyers, consumed lots of Red Bull, and hashed out how to implement crowd investing under current law. The hard part was minimizing compliance costs to keep the fundraising practical and affordable for small fundraising amounts... but we did it.
While crowd investing is now possible, there are important limitations:
- Only up to 35 un-accredited investors may invest.
To remain in compliance with the law, the total number of unaccredited investors - across all states - can not exceed 35. But, with the exception of investors in Massachusetts (see below), the start-up can raise from an unlimited number accredited investors (in CA and NY).
- Investors must be a resident of CA, NY, and MA.
These states have "blue sky" laws that allow un-accredited investors to invest, without requiring a costly investment prospectus (a few other states have laws that may possibly work, but you'd have to confirm with your lawyer).
- No advertising or general solicitation is allowed.
You can't broadcast your offering to the world. You can't post your deals on Facebook, Twitter, get mentioned in the press, put out an ad, etc.
- Companies must comply with various State laws.
CA and NY require filing a notice and paying a small fee. MA has no filing or fee, but has different compliance issues.
For your lawyer: The offering must also be "private" for purposes of federal law. http://taft.law.uc.edu/CCL/33Act/sec4.html
A friendly "cover our ass" disclaimer: WE DO NOT OFFER LEGAL ADVICE! We're providing this information so that you are informed enough to talk to your lawyer, who is the final authority. That's why they get paid the big bucks...
With that out of the way, here's some guidelines on compliance. First, all the states have a ban on advertising and general solicitation. Each state has their own legal code that handles offerings of securities.
California requires filing a Limited Offering Exemption Notice within 15 days after the first sale to a CA resident. There is a $25-$50 fee for fund raises under $500,000.
For your lawyer: Have them review California Corporations Code section 25102(f)
New York requires three forms be filed before any offering is directed to New York residents. You cannot start your offering until your registration is approved.
For your lawyer: Have them review New York's Securities Registration Information
Massachusetts does not require any forms to be filed or fees to be paid.
However, there is an additional wrinkle: there is a limit of 10 investors who are residents of MA. Also, unlike other states, the cap of 10 includes accredited investors who are located in MA (in this offering). If you want more than 10 accredited investors from MA, you'll have to wait for a future offering.
If you've reached your cap of 10 MA investors, you can have 25 unaccredited investors - and unlimited accredited ones - in the other states.
For your lawyer: Have them review MA Section 402. (a) and
950 CMR 14.400:
My company is in Ohio. I am incorporated in Delaware. Can I raise funding from residents of MA, NY, & CA?
Yes. It does not matter what state you are located or incorporated in, you still can raise funding from residents of MA, NY, & CA.
Why are you using state law, and not the federal Rule 506?
To raise money from unaccredited investors, Reg D, Rule 506 requires a detailed investment prospectus that can cost upwards of $10,000. Additionally, the startup must prove that each un-accredited investor is "sophisticated", which opens the company up to liability. NY, MA, and CA state law do not have these burdens.
I hear in the Fall of 2012, Rule 506 will be modified by the SEC, allowing general solicitation for accredited investors. If I do crowdfunding now, will I be able to take advantage of general solicitation later?
Yes, you can raise from accredited investors in the future using Regulation D, Rule 506, but not concurrently while raising from 35 un-accredited investors. You must do it in a future offering of securities.
How do I determine what is a future offering of securities?
This is a complicated subject you should speak to your lawyer about. But the overly simplistic version is that changing the terms of the deal, the price of your stock, and waiting a period of time after your first offering closes will make it more clear cut to the SEC that you are making a second offering.
Why can't I advertise or 'generally solicit' investors? What does this include?
The law prohibits any form of advertising when it comes to selling stock in your company. To be safe, any mention about your fundraising, in any public forum, should be avoided. This includes Facebook, Twitter, talking to the press, running a Google Adword, posting to Craigslist, etc.
By the act of submitting my startup on Wefunder, aren't I doing a prohibited general solicitation?
No. Fundraising terms on Wefunder are only visible to a close-knit, private community: investors who have created an account on Wefunder and completed an investor certification form that demonstrates their understanding of the risks of start-up investing. That is not the general public.
Can I submit a company on Wefunder, and post to Facebook and Twitter asking for 'followers'?
Yes. But you cannot mention anything about fundraising, nor even hint about it. You can ask for support, ideas, feedback, etc. Only if users follow you, create an account, and fill out a certification form, will the investing terms be visible.
Put simply, an accredited investor makes over $200,000 a year (if filing individually) or has over $1 million in assets. For more detail, read the Longer Definition.