Crowd control: preparing for the new world of equity-based crowdfunding.

• Author: Fields, Jared
• Position: Legal Brief

By the end of 2012, the Securities and Exchange Commission will issue regulations that lift the term "crowdfunding" from obscure corners of the internet and inject it into common parlance as a component of American capital markets. Under the new Jumpstart Our Business Startups Act (JOBS Act), crowdfunding will allow small businesses and startups to solicit equity investors from the online masses without filing registration statements with the SEC. The idea is to use the internet to connect entrepreneurs with prospective investors without going through traditional channels such as venture capital firms, private equity firms or angel investors.

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The concept of crowdfunding is not exactly new. Over the past several years, a number of websites have emerged to allow small businesses, artists and nonprofit organizations to solicit and collect a large volume of small-dollar contributions. The Economist reported in June that around 10 percent of the films shown at the Sundance and Cannes film festivals this year had been crowdfunded.

New Opportunities

Many entrepreneurs have employed "perks-based" crowdfunding, in which contributors receive some kind of non-financial, non-equity reward for their payment. For example, using a prominent perk-based crowdfunding site, Kickstarter, the creators of the Pebble wristwatch caught the world's attention in April 2012 by raising $10.3 million from nearly 69,000 investors. Their "perk" was to offer samples of the startup product to the first contributors.

Until now, however, it has been illegal under the securities laws for crowdfunding startups to offer equity shares in their companies. That will change when the SEC issues new rules to govern "equity crowdfunding." The JOBS Act authorizes equity crowdfunding by creating an exemption from the registration requirements of the Securities Act of 1933 for crowdfunding transactions.

Principal Limitations

As of the time of this article, the SEC has not yet issued its proposed rules, but the JOBS Act text itself provides some information about what will be some of the principal limitations on equity crowdfunding.

First, there are limitations on the size and nature of crowdfunded investments. On the issuing side, a company will be limited to raising $1 million in any 12-month period by selling its shares through crowdfunding. On the investor side, limitations depend on the investor's income or net worth. Specifically...