In President Obama’s JOBS Act, Crowdfunding means a very specific thing:  raising money from lots of investors through a registered broker-dealer or a “portal.” That kind of Crowdfunding won’t come into effect until January 1, 2013 or such later time as the SEC issues regulations. 

But the JOBS Act made another important change to the way companies can raise money from investors, and in the scheme of things this change might turn out to be even more important.

Background:  When a company raises money from investors it becomes subject to the securities laws, administered by the SEC. Big companies like Facebook are required to go through a long and expensive process of registering their stock with the government, but long ago the SEC adopted a much simpler set of rules for smaller companies, often referred to as Regulation D, or Reg D for short. Reg D provides for three main varieties of raising money legally:  a Rule 504 offering, a Rule 505 offering, and a Rule 506 offering.

Of these the Rule 506 offering is the simplest and most streamlined, in part because it allows the company to avoid state “blue sky” laws. Until now, however, Rule 506 has comes with one key limitation:  the company seeking to raise money could not engage in “general solicitation.” That means the company could look for investors through word of mouth, or from friends and family, or by using brokers, but it could not run a television advertisement or ask for money on the internet.

The JOBS Act changes that rule. As long as a company is willing to limit its investor pool to accredited investors – generally meaning institutional investors or investors with high incomes or high net worth – it may conduct a Rule 506 offering using general solicitation, and thereby reach a much larger audience than it could before.

By definition, accredited investors have more money than non-accredited investors. By definition, startup companies (and other companies) are looking for investors with money. It stands to reason that the market for “crowdfunded Rule 506 offerings” could become much larger than the market for Crowdfunding itself. In a true Crowdfunding offering, for example, the company can raise no more than $1 million and will likely end up dealing with many, many investors. In a crowdfunded Rule 506 offering, on the other hand, a company could raise $10 million from one investor that it found through the internet.

The SEC was required to issue regulations about “general solicitation” within 90 days after enactment of the JOBS Act. The regulations have been delayed, but probably not for too much longer. Within the next month or so we expect the ban on general solicitation to be lifted, allowing at least one form of “crowdfunding” to spring to life.