Through the highly publicized success of crowdfunding platforms operated by companies such as Kickstarter, Inc., Indiegogo, Inc. and CrowdRise, LLC, companies are increasingly considering crowdfunding as a source of new investment. There are three main crowdfunding models. The most commonly known model is the “rewards based” or “donation based” model, such as Kickstarter, Inc., where an individual receives a product or some kind of perk in return for their investment. This crowdfunding model is not considered to involve an offer or sale of securities and thus does not require an exemption from the Securities Act registration requirements.

The second type of crowdfunding is the traditional investment model. Under this model, companies sell ownership interests and the corresponding financial return online to investors. Popular crowdfunding platforms of this type include AngelList, LLC, FundersClub Inc. and CircleUp Network, Inc. An exemption from Securities Act registration exists under Rule 506(b) of Regulation D for companies offering these securities to an unlimited number of accredited investors and to no more than thirty-five non-accredited investors who meet certain sophistication requirements, although companies utilizing this exemption are prohibited from general advertising or general solicitation.

The third type of crowdfunding is a newly approved form of the traditional investment model that does permit general advertising and general solicitation for unregistered securities offerings, but: (1) only if they are made to accredited investors; and (2) only if the issuer complies with the additional provisions of the recently adopted Rule 506(c) of Regulation D. See Part II of this Blog Post for additional information about conducting offerings under Rule 506(c) of Regulation D.

In addition to these crowdfunding models, Congress has also taken action to further expand the crowdfunding opportunities available to companies with the passage of Title III of the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Title III directs the Securities and Exchange Commission (the “SEC”) to develop an offering exemption especially for crowdfunding in order to permit companies to raise up to $1 million from an unlimited number of investors, including non-accredited investors, through online “funding portals” registered with the SEC. The SEC has not yet adopted final rules for many of the JOBS Act provisions, including Title III, however it has issued some recent guidance that is instructive.

Under Section 201(c) of the JOBS Act, an exemption from broker-dealer registration is currently available for those persons conducting offerings in compliance with Rule 506 of Regulation D, solely because such person “maintains a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities.” Uncertainty existed over how this recently-created exemption would be interpreted and applied to investment crowdfunding platforms and whether such companies would still have to register as broker-dealers. On February 6, 2013 the SEC issued FAQs to provide further guidance on this exemption, clarifying that such persons cannot receive “compensation in connection with the purchase and sale of a security”, but compensation from co-investments in the securities is permitted. Following up on the February FAQs, in March 2013 the SEC’s Division of Trading and Markets issued no-action letters to two crowdfunding platforms, providing validation for the legality of their business model.

As a result of the recently enacted legislation rule changes and SEC guidance, a clear path is being laid for the crowdfunding community to more easily raise funds in this new platform. Look for Part II of this Blog Post for further information regarding offerings under Rule 506(c) of Regulation D that permit general advertising and general solicitation.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation.