Equity crowdfunding for SE Asian startups?
The effect of the JOBS Act on SE Asian crowdfunding from a legal point of view
On April 5, 2012, a U.S. law was enacted that impacts the way startups can raise money by selling shares to the public. Officially called the Jumpstart Our Business Startups Act, but more commonly known as the “JOBS Act,” this law seems to be just the beginning of a wider global trend to loosen legal restrictions from public fundraising (see, for example, Italy).
The JOBS Act is supposed to make equity crowdfunding by startups easier. In this article, I will focus on two of the ways: (1) “general solicitation” is now allowed in some cases, which potentially means that startups can ask people to buy their shares on a website or by other forms of public marketing; and (2) “Funding Portals” are now allowed, which means that startups should be able to crowdsource funds from the public through a new type of online investor matching service.
The JOBS Act
The JOBS Act is a group of modifications to existing U.S. securities laws, all aimed at easing government regulation of selling securities; your company’s stock is a form of a security–so if you want to sell stock in your company to raise funds, you need to understand securities laws.
So, the question is, how do these changes affect startups in Southeast Asia? Can startups here take advantage? Scroll to “Summary” near the end of this article to see the quick answer, or read on to learn more details.
General Solicitation is now allowed in some cases.
Under the JOBS Act startups can advertise or otherwise communicate to the U.S. general public that they are looking to sell equity. Prior to the JOBS Act, pretty much the only way a company in the U.S. could sell its shares to the general public was to first have an initial public offering (IPO). Now, there is an exemption that allows companies to directly tell the public that they are selling shares. Before you start designing a new landing page begging Americans for investment, however, there are some significant drawbacks and issues that accompany this exemption:
- There are more stringent verification requirements that all your new investors are “accredited.” This basically means that your company would have to proactively check to make sure your investors have enough wealth, in the eyes of the law, to be able to afford the investment.
- Further, there are some new proposed procedures that are very, very important. These are filings and other requirements that if you mess up, you basically will be banned from fundraising for a year. A year without fundraising could of course be disastrous for a startup.
- Most importantly for startups in Southeast Asia and the rest of the non-U.S. world, being able to solicit directly to the American public is only part of the story. Startups still have to obey the the securities laws of the country in which the startup is operating and also the laws of all the locations where it is trying to raise funds. There is a good chance these laws do not allow for general solicitation.
In summary, right now the new general solicitation allowance doesn’t seem to be such an advantage for startups, both within and outside the U.S.:
- You don’t need general solicitation for sites like Angel List. Startups still tend to get the best exposure from platforms such as Angel List, and general solicitation on Angel List is optional. Angel List does not rely on the new general solicitation allowance, and currently the general public cannot invest through Angel List, so there is no pressing need for startups to use general solicitation, at least for now.
- If a startup does decide to use general solicitation, this triggers other requirements that may be difficult to comply with. If a startup wanted to publicly request investment through its own website, that is now technically allowed under U.S. law. However, doing this would potentially trigger new requirements that would be quite onerous to your typical startup. Worse yet, if the startup fails to obey these new requirements, it could be effectively banned from fundraising in the U.S. for one year.
- Startups outside the U.S. have other considerations. Startups outside of the U.S. have to be sure they are not violating the securities laws of their home countries, or other countries from which they might be drawing investors. Just because general solicitation is allowed in the U.S. does not mean it is OK in other jurisdictions to which you are subject. In fact, it is likely not allowed–you need to check with a lawyer in your relevant jurisdictions.
Funding Portals will allow everyday people to crowdsource ventures and receive equity in exchange.
Under the JOBS Act a new type of online service is allowed that could match investors from the general public to startups that need capital. Unlike sites such as Angel List, the potential investors don’t have to be “accredited,” so not-so-wealthy people could invest small amounts into your startup.
The SEC is still deciding the final rules for this new mechanism, and the deadline for these new rules is not until the end of the year. Until the final new rules are decided by the SEC (and one other agency), as a practical matter, this part of the law is not yet in effect. Don’t expect the the new rules to actually go into effect in less than six months. However, the proposed rules specifically disallow non-U.S. startups from participating, and this is not likely to change with the final rules.
As a practical matter, however, participation by non-U.S. startups would be problematic regardless. First, there are the general solicitation issues discussed above (likely breaking the securities laws of their home countries, or other countries from which they might be drawing investors). Second, startups outside of the U.S. have to worry about their country’s corporate laws–could hundreds of new American investors even legally join your company? Ultimately, the Funding Portals will almost definitely exclude non-U.S. startups, just to avoid complications. (This is similar to how it is done in the U.K., and in Finland/Sweden.) If you are a non-U.S. investor, however, your money is likely welcomed. (They will of course disclaim that it is up to you to determine whether you are in compliance with all laws–like Angel List does).
Funding Portals vs. Angel List vs. Kickstarter:
- Angel List and similar equity crowdfunding sites that are operating now are not the same as the new proposed Funding Portals. While Angel List and the new Funding Portals will both match investors with startups, they will achieve their goals in two different ways. Angel List only allows “accredited” investors, and does not rely on the general solicitation exemption. Meanwhile, Funding Portals will allow anyone to invest, and will specifically depend on the general solicitation exemption. There will be a specific definition of what a “funding portal” is, and Angel List is using an alternative path (for now–it may expand into this area after the final rules). Local equity crowdfunding sites such as SeedAsia seem to work in the same manner–only accredited investors and no general solicitation.
- Kickstarter and similar reward-based crowdfunding sites are also not the same model. Under the Kickstarter model, the general public contributes money to a project, but they are not buying shares of a company. The funders from the general public receive no equity or upside in any company; instead they only receive some “thank you” reward, which can even be the new product itself that is being produced.
Now that the JOBS Act is being implemented in the U.S., does that open up new opportunities for crowdfunding for SE Asian startups? Not really.
General solicitation is now allowed in the U.S., but non-U.S. startups need to worry about violating securities laws in the areas in which they operate and from which they may draw investors. Just as before the JOBS Act, SE Asian startups can be listed on sites such as Angel List, but they didn’t need the general solicitation allowance for that. Further, it is probably not a good idea for these startups to use the general solicitation feature while on Angel List.
The new U.S. Funding Portals may be a game-changer (and in my humble opinion, this type of crowdfunding should change the startup/VC world in large ways), but right now we are still waiting for the final rules to come into effect, probably at the earliest the second quarter of 2014. And even once the new rules do come into effect, the new Funding Portals will likely disallow non-U.S. startups from participating (as is currently stated in the proposed rules). SE Asian startups will just have to wait until their own home countries pass their own versions of the JOBS Act. In the meantime, you can always move to Italy.
Notice: Nothing in this article should be considered the rendering of legal advice or other professional advice. You should consult an attorney in your relevant jurisdictions. Further, nothing in this article should be considered an endorsement or advertisement.
About the author:
Ed Sato is a U.S. corporate and securities attorney living in Bangkok. He also has a startup called ScoreNexus that focuses on online assessment tests. He can be reached via his website at emsato.com.