More than three and a half years after the JOBS Act’s passage, the Securities and Exchange Commission has released its rules for the critical Title III. The regulations won’t be fully into effect for more than a year, but its impact on the way small businesses, content creators, and new products can raise money cannot be overstated. More specifically, the equity crowdfunding provisions, and allowance for non-accredited investors to invest in private companies detailed within the JOBS Act have the ability to fundamentally change the way artists and entrepreneurs are able to interact with their fans and customers
What is the JOBS Act?
The Jumpstart Our Business Startups (JOBS) Act was passed in 2012 with the aim of encouraging startup and small business funding. These kinds of companies are described in the law as “emerging growth companies”, and are able to take advantage of the JOBS act if they have less than $1 Billion in gross annual revenue. It did this through three main provisions. The first is allowing non-accredited investors to invest in private companies, which before had only been available to Accredited Investors (people earning over $200,000 annually, or with a net worth of over $1,000,000)1. By allowing average people to invest in private companies regardless of their income, small companies and content creators have access to a much larger pool of investors and capital. This greatly increases the likelihood of companies reaching their fundraising targets, as well as allows anyone to take a financial stake in a company or product they believe in. Non-accredited investors who bring in less than $100,000 per year can invest in a crowd-funded campaign to the tune of $2,000 (or five percent of their net worth, whichever amount is higher). Anyone making more than $100,000 a year can invest up to 10% of his or her annual income into crowd-funded campaigns.
The second provision gives the ability to private companies looking to raise money to publicly announce and advertise their round of funding before, and during its progress. Prior to this change “SEC registration provided that the offering [was] not publicly advertised.2” This is a seemingly small, but critical change. Crowdfunding is entirely dependent on the ability of the project to mobilize a community and convince them to contribute. This would be impossible if the SEC prohibited any public awareness campaigns. However, should a project decide to generally solicit funds, they are subject to increased regulation by the SEC. The business must “file an advance Form D at least 15 days before any general solicitation (instead of the current requirement, 15 days after the first sale), submit general solicitation materials to the SEC, and include specific mandated legends on the materials.3” Doing any promotion via social media, announcements via website, or any other general solicitation before meeting the above requirements would put the project in danger of violating securities law, so companies looking to use equity crowd-funding should be familiar with all the regulations before launching a campaign.
The third key provision is the ability to actually raise money through crowdfunding, but in exchange for equity instead of rewards. Unlike rewards based crowdfunding, equity based crowdfunding requires issuing securities. This comes with a high degree of regulatory oversight to protect the non-accredited investors (685 pages of regulation for Title III alone). Therefore, it is incredibly important that anyone wishing to participate in equity based crowdfunding familiarizes themselves with the regulations and consults a lawyer if necessary. It is also important to note that artists will not be able to fund one off projects such as albums, or tours through equity crowdfunding. This type of funding is only available for activities that will generate equity, debt, or derivatives. The amount companies are allowed to raise through equity crowdfunding has also been capped at $1 Million in any twelve-month period.
A large part of the regulation requires being transparent with investors. VentureBeat advises “that you disclose anything about your business that would have a material impact on an investor’s decision to back it: disclosures could include everything from the fact that you’ve taken on substantial debt to the fact that your mother-in-law owns 70 percent of the business or that your business could fail if coconut water (your business model) goes out of vogue or that one customer makes up 80 percent of your business4.” After all the relevant information has been filed, the issuer has two choices of how to issue the equity. It can either be issued by a broker/dealer, or through an SEC approved funding portal.
The new artist fan relationship
The ability for the general public to invest in the business of an artist or creative enterprise will fundamentally change the nature of the relationship between creators and their fans. These new rules “open the door for fans to become business partners with a financial interest in a label’s success, for example, providing another way to support artists without the charitable concept of current crowdfunding5.” This could greatly change how we think about the concept of music ownership. It could no longer be used to describe owning a recording of music, but include ownership of a piece of the intellectual property as well.
By making the shift from stakeholder to shareholder, the fan will also potentially have increased visibility into the business or decision making of the artist. It remains to be seen what fiduciary duty the artist might have to the equity holding crowd, or how fans might be represented, if at all, in the board of directors. Complicating the matter is the fact that the shares of the company will be illiquid (unable to be traded on public markets), and therefore will not be able to be converted into cash at short notice. In a typical startup, owners’ shares can only be made liquid by an IPO, a merger, or an acquisition. This is unlikely to apply to artists unless the buyer becomes a record label, a production house, or a publishing company chasing very successful talent. So the risks to fans are enormous, and any shares owned would only have theoretical value. The best bet then is to hope for dividends (similar to artist earnings on royalties).
How then, are investors supposed to see a return on their investment other than dividends? Luckily, many fans that invest in artists will do so because they support the art, and want to feel a true sense of community and ownership. These shareholders will not be concerned just with liquidity. The rest however, will at some time desire to cash out. This could potentially be done in a number of ways.
Firstly, the artist may offer to buyback the shares of those looking for liquidity at some point in the future. This would be good for both artist and fan because the artist will regain more ownership, and the fan will have cash in their pocket. Secondly, the record label may also offer to buy the shares of fans looking for liquidity. Allowing fans to sell to another entity invested in the success of the artist keeps the shares within the artist’s existing stakeholder base. If the label is publicly traded, such as Warner or Universal, the shares of the artist might be able to be exchanged for label shares, which are liquid. Alternatively, marketplaces may pop up where shares can be sold to existing shareholders, or anyone looking to acquire stock in an artist not currently issuing.
Bridging the gap
The new rules do not take effect until January 29th, 2016. Until then the closest platform to true equity crowdfunding is TapTape, a startup from M.I.T. Sloan launched at Hacking Arts.
TapTape offers its users the ability to invest money in artists on its platform in exchange for bonuses, but also has provisions for investors to receive profits on successful projects. Those profits are currently paid in TapCoins, which can be used to purchase concert tickets or artist merchandise through TapTape’s site. It seems this is the happy middle, providing fans a way to financially back artists while still having the ability to enjoy an upside on successful projects. TapTape can also be used for one off projects for which true equity crowdfunding is not practical.
While these new platforms and investment vehicles give fans a unique opportunity to take a stake in their favorite artist work, it also presents unique challenges for artist and fan alike. Both parties would do well to remember that ultimately they are dealing with the sale of securities.
For artists this means a degree of oversight they are not used to dealing with, and the information they might be required to disclose may be discomforting. This oversight is also complex, and any misrepresentations could result in heavy fines, or potentially criminal charges. They will also have increased legal responsibility to their fans, which may influence or even dictate what business or artistic direction they wish to pursue.
For fans this means they are sharing in the risk of an already highly risky business in a medium that will not likely be completely liquid––at least until a trade in secondary artist stocks develops informally. Labels were prepared to loose money on most artists against the expectation of doing well with a few. So a fan should also hedge his bets among other artists if the expectation is one of monetary reward. Otherwise, there can be comfort in the idea of jumpstarting a favorite’s artist career, where return on investment can be traded for more proximity, perhaps, but surely more perks.
By John Lahr
1. “Investor Bulletin: Accredited Investors.” Investor.gov. Securities and Exchange Commission, 23 Sept. 2013. Web. 08 Dec. 2015.
2. Brummer, Chris, and Daniel Gorgfine. “The JOBS Act Isn’t All ‘Crowdfunding'” Forbes. Forbes Magazine, 8 Oct. 2013. Web. 08 Dec. 2015.
3. Wallin, Joseph M. “General Solicitation and Start-up Capital Raising: Existing Guidance and New Questions.” (n.d.): n. pag. Http://www.startuplawblog.com/. Davis Wright Tremaine LLP, 2013. Web. 8 Dec. 2015.
4. Neiss, Sherwood. “The SEC’s New 685-page Crowdfunding Rules: What You Need To know.” VentureBeat.com. VentureBeat, 2 Nov. 2015. Web. 09 Dec. 2015.
5. Rys, Dan. “New SEC Rules to Allow Companies to Crowdfund Investment.” Billboard. N.p., 3 Nov. 2015. Web. 09 Dec. 2015.