As Crowdfunding gains traction, Crowdfunding portals are springing up and marketing themselves aggressively to entrepreneurs and prospective investors.

No, I take that back. Websites are springing up and marketing themselves aggressively to entrepreneurs and prospective investors, but technically there aren’t any “Crowdfunding portals” yet. Crowdfunding portals are a creature of the JOBS Act, and the JOBS Act hasn’t yet come into effect because the Securities and Exchange Commission (SEC) hasn’t yet issued regulations.

If the websites springing up today are not really Crowdfunding portals, then what are they? Are they legal? That matters a lot for entrepreneurs.

Background

The JOBS Act created two kinds of Crowdfunding:

1. Using one kind of Crowdfunding, companies can raise up to $1 million from in unlimited number of investors through Internet “portals” that would be registered with the SEC and licensed by FINRA.
2. Using the other kind, companies can use “general solicitation” to raise an unlimited amount of money from “accredited investors” by following Rule 506 issued by the SEC under Regulation D.

But neither kind of Crowdfunding is available yet.

Today, we see websites that combine the concept of a “portal” with a traditional private offering of securities. At these sites, accredited investors sign up to review companies, and companies sign up to raise money from investors. If everything goes right you end up with a happy entrepreneur and a legal Rule 506 offering.

What Could Go Wrong?

By definition, these Internet sites are not Crowdfunding portals and what they do is not JOBS Act Crowdfunding. For the sites to be legal they must satisfy the securities law rules as they existed before the JOBS Act. And it turns out that it’s not easy to mesh the very fast, very public world of the Internet with the rules in place long before the Internet was a twinkle in Al Gore’s eye.

These are a few of the tough issues these sites face:

• Until the SEC issues Crowdfunding regulations, companies are not allowed to use “general solicitation” to attract investors. But if you visit some of these sites – public to anyone with Internet access – you see the companies listed.
• If a portal isn’t careful, it might end up with one or more unaccredited investors, disqualifying the whole offering.
• The sites generally don’t work for free – they are paid by the companies that raise money. In general, only a licensed broker can receive compensation in connection with the sale of securities.
• Some sites provide “due diligence” on companies, offering to help investors to separate the good from the bad. That kind of service generally requires a license as an investment advisor.
• State securities regulators can be even more aggressive than the SEC. If an offering violates Federal law then it probably violates state law, too.

Some sites seem more aggressive legally than others. Entrepreneurs should pay attention.

Why Does It Matter to the Entrepreneur?

If a website raises money improperly, the website can find itself in hot water. The operators of the website may be fined, banned from the securities industry (thus missing out on Crowdfunding when the SEC finally issues regulations), even go to jail.

But it’s no picnic for the entrepreneur and his or her company, either. If the portal does something wrong it likely means the company engaged in an unregistered, and therefore illegal, public offering of securities. The entrepreneur can also be fined, banned from the securities industry, or even go to jail. Moreover, the entrepreneur could be forced to give all the money back to the investors.

Conclusion

Raising money has always been hard. The internet and the JOBS Act are making it easier, but in the Wild West version of Crowdfunding we live in today, entrepreneurs have to be picky about their portals.

Questions? Let me know.