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Help Change the SEC Rules for Crowdfunding Startups

Posted by Seth Elliott On July - 7 - 2010

VC Handing Out CashPaul Spinrad, Jenny Kassan and the folks at the Sustainable Economies Law Center have done something that every entrepreneur should know about. They’ve initiated a process to help make crowdfunding startups and small businesses a reality from a legal perspective.

As it stands now, most forms of crowdfunding are ILLEGAL. You can read more details below, but here is what you need to do to help:

PLEASE submit a comment to the SEC. This is how to do it:


  1. Send an email to the SEC at rule-comments@sec.gov

  2. I would be very appreciative if you would bcc me so I can track the submission of the comments – please use the email address SECpetition@unchained-entrepreneur.com

  3. In the subject line write “Re: File #4-605″

  4. In the body of your email write “There follows my comments in regards to the petition for rulemaking change #4-605″

  5. Provide a comment that is supportive of the rulechange. Of course you should feel free to discuss your personal experiences, amplify points or even suggest changes to the proposed petition (for example, I believe that the threshold should be $250,000 and $500 per individual). The key point is to send a comment that tells the SEC you would like to see this rulechange or something similar adopted.

  6. I’ve also created a Facebook page for this initiative. You may want to go there and “Like” the page. I will post updates on the process and initiatives there.

  7. Please share this post with anyone you think will take action via Email, Twitter, Facebook, etc.


Now, if you’re interested, some background.

Over the last year the idea of crowdsourcing and crowdfunding startups has gotten a great deal of attention. If you’re not familiar with this concept – it essentially involves accessing a large group (primarily through the use of Social Media) and obtaining small amounts of investment funding from a number of individuals (aggregating into a substantive investment amount).

There are several websites that have attempted to tackle this problem ranging from Kickstarter and IndieGoGo (these are contribution sites – there is no financial return associated when you provide funds) to Prosper and other similar sites (these are Peer to Peer lending sites, where an individual can choose to lend funds to specific businesses) to Profounder (a yet to be launched site from the founder of Kiva that is looking to “crack” the crowdfunding model).

However, as I mentioned there is a dirty little secret associated with the crowdfunding concept – most attempts to make use of it in the United States would actually violate the Security Act of 1933! You read that correctly – the way things stand today, typical attempts to crowdfund would be illegal.

Here’s a brief review of why.

According to the 1933 Act, any offer to sell securities must be either registered with the SEC or meet a specifically defined exemption from the Act. Before we address those exemptions, it’s worth understanding what the SEC considers a “security.”

There is a long definition in the Act, but essentially a security is any instrument that creates ownership or allows for participation in financial returns qualifies. Basically, if an individual provides growth capital on a basis other than as a gift or donation, it’s deemed to be a security and subject to the Act (there are some exceptions, most notably providing a loan under certain circumstances). As you can see, any serious attempt to source investment capital using crowdfunding will involve the issuance of securities.

This brings us to the subject of registration and exemptions pursuant to the Securities Act.

Registering an offering with the SEC is an expensive and time consuming process, requiring (among other items) audited financial statements. With certain exceptions, registrations are used for Initial Public Offerings or companies that are already listed on a public exchange.

There are, however, several defined exemptions under which a company can raise funds without a registration statement. These most well known and commonly used exemptions include Regulation D (Rule 504, 505, and 506) and Regulation A.

Regulation D is most often invoked when a company raises funds without a registration. At some point in the future if there is interest, I may post a more detailed description of the various exemptions. For now, it’s sufficient to know that the Regulation D and Regulation A exemptions have several disadvantages for the purposes of crowdfunding, most notably:


  • Regulation D Rule 506 is only applicable if the investors are all accredited investors (which means they must have a certain net worth or annual income level. This exemption is most often used in VC transactions.

  • Regulation D Rule 505 does allow for non-accredited investors, but only 35 may participate AND the level of disclosure that must be provided to them approaches that of a registration statement

  • Regulation D Rule 504 appears to be of use for small companies. This exemption limits capital raises to $1 million in any 12 month period, and it does not limit participation to accredited investors. However, using this exemption subjects the issuer to state regulatory requirements in any jurisdiction where there are investors. This can be quite onerous and often makes this exemption prohibitive for all practical purposes.

  • All of the Regulation D exemptions have a prohibition on general solicitation – which likely prohibits using these exemptions for most crowdfunding purposes

  • Regulation A seems promising on a first read, particularly as it is designed to “exempt from registration small securities offerings.” Unfortunately, the exemption requires the creation of a disclosure document that, for all intents and purposes, mimics a registration statement (except audited financial statements are not required). Furthermore, the SEC review process of these offering documents in practice has proven to be costly and time consuming.



So – that’s the background. Elements of the Securities Act as currently constituted essentially prevent using crowdfunding as a viable financing mechanism. Enter Paul Spinrad.

Paul became aware of the securities laws issues that I’ve summarized – and he decided to do something about it. After a bit or research and discussion with the SEC, he discovered that the SEC could make changes to these exemptions without requiring Congressional review. Furthermore, the SEC has a process by which interested members of the public can submit petitions for suggested rule changes – which are then open for public comment

Paul then hooked up with Jenny Kassan of the Katovich Law Group and the Sustainable Economies Law Center. She agreed for a token fee to draft and submit a petition to the SEC for a new exemption with crowdfunding in mind. Paul raised $1,000 in donations (in 8 days using IndieGoGo) and the team put together the petition. It was submitted to the SEC as of July 1st. If you’re interested, you can read the full details of how this came about directly from Paul.

Essentially, the petition calls for a specific exemption that will allow companies to raise up to $100,000 from non-accredited individual investors. Under this proposal, each individual could invest a maximum of $100. You can review the entire petition here. It’s file #4-605 title “Request for rulemaking to exempt securities offerings up to $100,000 with $100 maximum per investor from registration.” (I didn’t link directly to it as it is a PDF file). I encourage you to read the full document – it is only 9 pages long.

It is critical that we develop a groundswell of support for this initiative. We need to send a signal to the SEC that this rulechange should be adopted. The way to do that is by sending positive comments to the SEC. Please follow the instructions at the start of this post to do so.

Thanks for your support!

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About the Author

I have spent the last 15 years advising entrepreneurs on starting and growing their businesses, as well as assisting in financing those growth efforts. I have also been an entrepreneur on several occasions myself. By writing this blog, I hope to provide actionable advice on how to achieve your goals and become more successful.
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  • http://twitter.com/jonathanlea Jonathan Lea

    Good luck with your SEC dealings. I see an Australian company that is developing a water rcycling shower is successfully raising money online: http://www.recyclingshower.com.au/how-to-invest/

    In the UK there are also legal problems when trying to adopt crowdfunding (although yet to see any commentary on this). The main sticking point is that if you offer shares to over 100 people this becomes an offer to the public which has to involve a recognised stock exchange and a prospectus has to be produced and appproved by the relevant listing authority. However, for under 100 people I don't think the legal hoops are too bad/onerous – will look into it…

    http://twitter.com/jonathanlea

  • http://twitter.com/jonathanlea Jonathan Lea

    Good luck with your SEC dealings. I see an Australian company that is developing a water rcycling shower is successfully raising money online: http://www.recyclingshower.com.au/how-to-invest/

    In the UK there are also legal problems when trying to adopt crowdfunding (although yet to see any commentary on this). The main sticking point is that if you offer shares to over 100 people this becomes an offer to the public which has to involve a recognised stock exchange and a prospectus has to be produced and appproved by the relevant listing authority. However, for under 100 people I don't think the legal hoops are too bad/onerous – will look into it…

    http://twitter.com/jonathanlea