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What's All the Talk about Crowdfunding?

If you're a small business owner in need of financing, someone who looks for innovative investing opportunities, a fundraiser looking for ways to reach greater numbers of budding philanthropists, or simply someone who follows technological trends, you have probably heard the term "crowdfunding." A concept that has been gaining popularity in recent years, crowdfunding refers to a process of raising money for a business, cause, or project via low-dollar contributions over the Internet. For example, movie director Spike Lee used crowdfunding to help fund his latest film, while winter Olympians used crowdfunding to help get to Sochi and pursue their dreams. So what is crowdfunding, and what opportunities exist for business owners and investors?

History of crowdfunding

Crowdfunding--or "crowdsourcing" as it was originally known--started more than a decade ago when fans of a UK-based rock band started an effort to help the band finance a tour through online donations. After that first successful endeavor, the band used the same method to finance other recording and promotional projects. Other artists followed suit, and crowdsourcing became a popular way for budding artists to bring their visions into being.

Shortly thereafter, online portals began to crop up to help organizations in both the nonprofit and for-profit sectors raise money via the Web. Through these companies, donors typically commit funds in exchange for small rewards or perks (e.g., discounted products and tickets to events). Alternatively, some crowdfunding platforms facilitate loans, while others facilitate equity arrangements for "accredited" investors (generally those with incomes greater than $200,000 and net worths greater than $1 million, excluding the value of their homes). Even scientists and academics have entered the arena, using crowdfunding as a way to generate funding for research projects.

In 2010, a small group of entrepreneurs organized a lobbying initiative and approached Washington about using crowdfunding as a means for small businesses to raise money by selling equity investments to nonaccredited (i.e., everyday) investors. Their efforts helped spur passage of the Jumpstart Our Business Startups (JOBS) Act, signed by President Obama in April 2012. Among the provisions in the law was one that allows businesses to raise up to $1 million by selling securities to nonaccredited investors through a brokerage or online portal approved by the Securities & Exchange Commission (SEC). The SEC was then tasked with drafting and implementing the specific regulations. In October 2013, the commission released its proposed rules for comment. Final regulations are expected later in 2014.

Summary of proposed rules

The proposed rules limit the amounts that companies can raise and individuals can invest:

  • A company can raise up to $1 million over a 12-month period via crowdfunding
  • Investors can invest up to certain amounts over a 12-month period based on their annual income and net worth. Those with an annual income and net worth of less than $100,000 can invest up to $2,000 or 5% of their annual income or net worth, whichever is greater. Those with an annual income or net worth of $100,000 or more may invest up to 10% of their annual income or net worth, whichever is greater, up to a maximum of $100,000 in securities purchased via crowdfunding over the 12-month period.

The proposal also provides parameters for the type of information a business needs to provide to the SEC, potential investors, and the organization facilitating the online offering. The required information includes:

  • Information about officers, directors, and those who own 20% or more of the company
  • A description of the company's business and how the crowdfunding proceeds will be used
  • The total funding target, the public offering price, the deadline for reaching the funding target, and whether the company intends to accept amounts over the funding target
  • A description of the company's financial condition, as well as financial statements that may have to be audited and accompanied by the organization's tax returns

Companies using crowdfunding would then need to provide an annual report to both the SEC and its investors.

In addition, organizations that facilitate the crowdfunding investments--or "intermediaries"--would need to follow specific rules, including:

  • Provide educational materials for investors
  • Take steps to reduce the chances of fraudulent activity
  • Provide access to information about the business raising funds and its offering
  • Offer communication channels to allow discussions about the various offerings listed
  • Facilitate the offer and sale
  • Register with the SEC

Investors and business owners stay tuned ... Final regulations are scheduled to be released by the SEC later this year.

Businesses considering crowdfunding as a way to raise money will need to weigh the potential risks and gains. For more information, business owners can view a crowdfunding tutorial available at the Small Business Administration's website, www.sba.gov.

IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2020.