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General Solicitation & Equity Crowdfunding

The Jumpstart Our Business Startups ("JOBS") Act was passed in 2012 to increase business' access to capital. Perhaps two of the most notable provisions of the JOBS Act require the Securities and Exchange Commission ("SEC") to promulgate rules that: (a) provide an exception to "the prohibition against general solicitation or general advertising" for offerings made pursuant to Rule 506 and (b) enable equity crowdfunding.

Registration Requirement

The Securities Act of 1933 mandates the registration of an offer to sell securities, e.g. an ownership interest in a business, with the Securities and Exchange Commission ("SEC"); however, such Act also sets forth various types of offers that are exempt from the registration requirement. Regulation D contains three (3) such exemptions in Rules 504, 505, and 506.

a) General Solicitation Exception

Unless an offer is registered with the SEC, Section 5 of the Securities Act of 1933 prohibits "general solicitation" as to a particular offer. Such general solicitations likely include advertisements published in newspapers and magazines, public websites, communications broadcasted over television and radio, and seminars where attendees have been invited by general solicitation or general advertising.

Section 201 of the JOBS Act requires the SEC to promulgate rules that will exempt some offerings of securities that are not registered with the SEC from the aforementioned prohibition as to "general solicitation". Recently, the SEC promulgated these rules, which created a new type of offering in Regulation D called a Rule 506(c) offering. The following are attributes of Rule 506(c) offerings:

  • Advertising permitted
  • No individual investor investment value limits
  • No maximum fundraising limits
  • Only verified accredited investors

While the new exception to the prohibition as to "general solicitation" has been interpreted by some as equity crowdfunding, it's not, at least in the form required by the JOBS Act.

b) Equity Crowdfunding

The concept of crowdfunding, via portals like Kickstarter, has existed for some time in the United States; however, such crowdfunding can accurately be described as "donation crowdfunding" because those individuals or businesses who fund the businesses or projects via such portals do not receive ownership interests for the monetary contributions they make, largely as the result of restrictions imposed by federal securities laws.

The form of equity crowdfuding prescribed by Section 302(a) of the JOBS Act, requires the creation of a type of offering with the following attributes:

  • Advertising prohibited, other than directing investors to broker portals
  • Individual investor investment limits
  • $1,000,000 maximum fundraising during a 12-month period
  • Both accredited and non-accredited investors

Unfortunately, the SEC has not indicated: (i) when such a rule or rule(s) will be promulgated; nor (ii) the particular form of such rule or rules.

Given the restrictions inherent in the form of equity crowdfunding prescribed in Section 302(a) of the JOBS Act, why would startups not simply offer securities pursuant to Rule 506(c)? While the answer to that question will vary from business to business, one possibility is that the definition of "accredited investor" greatly limits the pool of potential investors and equity crowdfunding offerings are open to both accredited and non-accredited investors.

What Is an Accredited Investor?

An accredited investor is a person:

  • Who earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or
  • Has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

This brief overview of some important considerations associated with general solicitation and equity crowdfunding is by no means comprehensive. Always seek the advice of a competent professional when making important legal decisions.

Steve Cook is an llc formation lawyer at Cook & Cook. Although his office is located in Mesa, Arizona, he represents clients throughout the Phoenix, Arizona Metropolitan area including the following east valley cities: Scottsdale, Paradise Valley, Tempe, Chandler, & Gilbert.

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