by Mark R. Sullivan, Esq.
A new trend for raising capital is a talking point for small business owners. Small business owners express tremendous interest in using crowdfunding platforms to raise capital by selling shares in the business or by selling debt securities like a note or bond.
What is driving all of this interest? The 2013 JOBS Act and the regulations that the Securities and Exchange Commission has issued about that act.
Selling securities is heavily-regulated. Current laws are designed to protect investors by requiring companies that want to sell securities to disclose all of the information a prudent investor would need to know in order to make an informed decision to buy. The most important law, the big Kahuna, is the Securities Act of 1933 (The 33 Act). The 33 Act requires a company issuing the securities to put together a detailed offering document containing extensive, specific information about the company, including financial information (which must be audited by independent accountants); this document must be filed or “registered” with the SEC and reviewed by its staff before any securities can be sold. The staff of the SEC insists that all of the information in the document is clear and complete. Usually, the securities are sold with the assistance of an underwriter. This process is very expensive and is out of reach for most small businesses.
Most small business owners look at the other options available. There are exemptions from the registration requirements of the 33 Act for sales of securities to folks who don’t need the protection created by preparing a big, reviewed and audited disclosure document. That is where the JOBS Act has created some buzz.
One of the most interesting exemptions available is set out in Rule 506(c) of the 33 Act. This rule (part of which was created by the JOBS Act) permits companies to sell securities using the internet to wealthy, sophisticated investors (accredited investors). In this case, there is no need to register the offering under the 33 Act and that makes it much less costly to raise the money. Investment crowdfunding! What a concept! Hence, the tremendous interest.
(You knew it was coming, didn’t you?)
The exemptions that permit investment crowdfunding only exempt the company issuing the securities from the registration requirements of the 33 Act. They do NOT exempt the company from another, really big part of the 33 Act: what we securities lawyers call “the anti-fraud” provisions.
“Now, hold on a minute,” you say. “I’m not going to commit fraud while my company sells securities!” And, I know what you mean. Of course, you don’t intend to defraud and, lacking the requisite intent, cannot commit fraud.
But hold on: “Fraud” under the 33 Act does not involve intent to defraud at all. Nope! The 33 Act’s antifraud provisions require that the company selling the securities tells a prospective buyer everything the buyer needs to know in order to make an intelligent decision to invest. So, the company cannot say anything that is not true about the company or not say (omit to say) anything that is important to a prospective investor.