Investor Alert: Entrepreneurs and Crowdfunding

Jun 27

Securities Commissioner John Morgan today urged small businesses and entrepreneurs to be aware of the potential regulatory pitfalls in "crowdfunding,"an online money-raising strategy sanctioned by the federal Jumpstart Our Business Startups (JOBS) Act.

Through crowdfunding, individuals will be able to invest in start-ups through a broker-dealer or a "funding portal,"which is a website that advertises the investment offering and facilitates payment from investors to the company issuing shares. Funding portals cannot provide investment advice.

Morgan warned small businesses not to start raising money until the Securities and Exchange Commission adopts rules governing crowdfunding. The SEC may complete its rulemaking in early 2013. Until then, Morgan said, state and federal securities law prohibitions remain in place against publicly accessible Internet-based securities offerings.

Once the crowdfunding provision of the JOBS Act is in full effect, a small business will be allowed to raise up to $1 million in a 12-month period by selling securities to investors without registering the offering with state or federal securities regulators.

Morgan highlighted additional crowdfunding concerns for small businesses:

Don't discount disclosure. The crowdfunding exemption is only an exemption from securities law registration requirements. The requirements of federal and state securities laws regarding disclosures, including disclosure of all material facts and risks to investors, remain in place. Failure to comply with disclosure requirements exposes businesses to regulatory actions and lawsuits by private investors.

Carefully choose a broker or funding portal. Be aware of unscrupulous persons offering to take fees from you now to help you raise money over the Internet. Because the crowdfunding exemption has not yet been implemented, such offers could be a scam or indicate that the individual making the offer is unfamiliar with the intricacies of the new law.

If your broker or funding portal does not comply with the SEC's upcoming rules, you may be subject to liability for an unregistered offering. Ask questions of the broker or representative of the funding portal to make sure they are thoroughly familiar with the requirements of the law.

Don't go it alone. The crowdfunding exemption is meant to lower your costs by exempting $1 million or less in fundraising efforts from registration. However, a small business using this exemption will still need legal guidance on complying with the law as well as general federal and state securities laws. Consider speaking with a licensed and experienced securities law attorney to help you in your offering.

Consider your funding alternatives. Crowdfunding may be less expensive than a public offering of securities, but it will be more expensive than some alternatives. Federal and state securities laws provide other ways for a company to raise money from a limited number of investors with little cost.

Before taking any actions, small business owners, entrepreneurs, and potential investors with questions about crowdfunding offerings should contact the Texas State Securities Board at 512-305-8300.

Additional information on crowdfunding is available from the Texas State Securities Board and through the North American Securities Administrators Association.