Legal Issues of Crowd Sourcing Your Funding Through Equity

Posted by Rebekkah On January - 29 - 2013 0 Comment

One factor shared by all startups and growing small businesses is a need for capital. The more successful a company is after its launch, the more capital it will require. The nature of all business is that growth consumes cash, and fast growth consumes cash fast. Debt, equity, or combinations of both are used to fund this demand for cash.

A small business can secure any level of debt that its creditworthiness will support. Debt carries certain advantages and disadvantage for a small business. The primary limitation is that most small businesses cannot acquire sufficient debt to support its capital needs.

Selling stock or equity in a company presents a decidedly different scenario. The primary advantage of equity is that it can be raised on the prospects of a company’s success, rather than its current credit standing.

Laws Governing the Sales of Securities

The Great Depression of the 1930s occurred in part because of the reckless sale of and speculation in the stock of thousands of companies. As a consequence, Congress passed laws in 1934 and 1935 to regulate the sale and transfer of stock and securities. The primary regulatory body for this function is the Securities and Exchange Commission. Since the passage of these laws, all equity funding for companies is governed by federal law. Each state has its own laws and regulations that address securities transactions. The SEC requires that any company seeking to sell stock to the public file a registration statement. This is how companies go public.

A registration statement is quite complex. It requires lawyers and accountants. The expenses related to the process can be significant. To make it somewhat easier for smaller companies, the SEC established Regulation D, or Reg D. Under Rules 504, 505 and 506 of Reg D, companies can raise money under an exemption from registration. These rules are extremely stringent and detailed. Individuals that raise money and violate the particulars of the exemption face serious consequences, including a possible prison sentence. This has limited the use of Reg D for small company financing.

The JOBS Act

One of the most significant laws affecting small businesses became law in April of 2012. The Jumpstart Our Business Startups (JOBS) Act encourages the formation and financing of small businesses. To aid in this objective, the SEC is tasked with modifying the Reg D rules to allow small companies to use the Internet and crowd funding to raise money. This is an extremely significant change that will affect thousands of companies. It has not yet received the media coverage it will in the future. Forbes magazine ran an excellent article highlighting the major aspects of the law, and it changes.

Among the details, there are two primary and critical changes to previous Reg D limitation. The first change increases the number of small investors that can be allowed to invest from thirty-five to one thousand. The second change allows a company to advertise its sale of stock. Using the Internet to attract a group of investors opens an entirely new dimension for funding small businesses.

There are, of course, a number of additional details to the law that are beneficial. The net effect of this new opportunity to raise capital will be an extremely positive one.

About the Author:

This article was written and provided to eFinancial Resource Center by a guest contributor Donald Turner. Donald is an avid writer of finance articles on the web, in coordination with Craig Lynd on behalf of KEL Credit Repair. In need of a credit repair attorney due to credit issues with your business? Check them out and see what they can do for you.

If you would like to be a guest author for eFinancial Resource Center, please visit our Guest Posts page.

Comments are closed.