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5 Key Regulations to Get Right in Crowdfunding

Crowdfunding-keyFrom the newest design inventions to the Thai food truck that showed up in your town last week, the crowdfunding movement is allowing individuals to unleash their entrepreneurial spirit and turn their dreams into reality. By sharing their ideas on the web, users can raise funds to support the launch of their small businesses.

Numerous crowdfunding platforms exist, many focusing on the type of project being funded. For example, certain platforms serve non-profits and philanthropic causes, music, theatre, small business and so forth. Even with such specialization, investing comes with risk. Crowdfunding indeed opens investment opportunities to a new pool of potential stakeholders.  Many of those investors may not fully understand the risks involved. During the next few weeks on AICPA Insights, we will look at the benefits and risks of crowdfunding.

Before the federal Jumpstart Our Business Startups Act of 2012, only well-heeled investors had the chance to buy a stake in many start-ups and emerging companies. The JOBS Act changed all that by opening up crowdfunding beyond “accredited investors” with a net worth of at least $1 million or a family income of at least $300,000. However, equity crowdfunding--a less formal fundraising platform where a supporter receives partial ownership in the company in exchange for their investment--was on hold while the Securities and Exchange Commission developed regulations for putting it into action.

The Commission has now proposed rules that would allow a much wider pool of ordinary investors to buy stakes in emerging companies through online platforms. That’s an exciting prospect for many entrepreneurs and investors, but it’s important to maintain smart safeguards at the same time. In a letter to the SEC commenting on the proposed rules, the AICPA offered several recommendations that would protect investors in the crowdfunding environment.  

  • Independence. The AICPA calls for the use of AICPA or SEC independence standards, as appropriate, because they would provide the proper level of independence and would minimize confusion, complexity and cost.
  • Standards. The AICPA supports applying existing standards to crowdfunding offerings and spoke out against developing new independence, review or auditing standards specifically for crowdfunding issues. In response to an SEC question in the proposal, the AICPA also advises against allowing crowdfunding issuers to include less than a full set of financial statements as defined by U.S. generally accepted accounting principles.
  • Financial reporting. The AICPA agrees with requiring U.S. GAAP for financial statements for targeted offerings more than $100,000. However, given that start-ups and other small companies are more likely to use crowdfunding, and since the JOBS Act was intended to spur business development and job creation, the AICPA notes that other comprehensive bases of accounting, such as tax basis or the Financial Reporting Framework for Small- and Medium-Sized Entities, could be reasonable alternatives. Targeted offerings, both above and below $100,000, could benefit from cost savings while maintaining appropriate disclosure and transparency.
  • Tax returns. The AICPA questions the proposed public disclosure of tax returns for issuers seeking less than $100,000. It notes that the public may not understand differences between financial statements and tax returns and that disclosure could raise the risk of identity theft and fraud. If tax returns are made public, the AICPA recommends the redaction of personally identifiable information, such as business identifiers, and urges further study of this proposal.
  • Financial statement timing. The AICPA also offers recommendations on the dates and timing of issuers’ financial statements –both interim and year-end. The AICPA calls for a review of the interim statements under the same standards used to review or audit the year-end financial statements, whether they were statements on standards for accounting and review services, GAAP or Public Company Accounting Oversight Board auditing standards.

The National Venture Capital Association reports that about 40% of venture-backed companies fail and another 40% produce modest returns. Start-ups bring vitality and innovation to the marketplace, but they also entail risk, especially when less sophisticated investors and entrepreneurs are involved. The AICPA believes that proper procedures and requirements will help mitigate that risk and improve transparency and cost effectiveness.

What has been your experience with crowdfunding? Do you think this new pool of investors really understands the risks involved?

Charles E. Landes, CPA, Vice President, Professional Standards and Services, American Institute of CPAs.

Crowdfunding image via Shutterstock

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