On October 30, 2015, the Securities and Exchange Commission (SEC) adopted its final rules governing the offer and sale of securities under new Section 4(a)(6) of the Securities Act of 1933, also known as equity crowdfunding. These rules, adopted pursuant to Title III of the JOBS Act, are designed to facilitate capital formation by early stage and startup companies, while offering additional protections to potential investors.
Regulation Crowdfunding, as the final rules are known, conditionally exempts the securities sold in a crowdfunding transaction from registration and any state blue sky laws, while permitting individuals to invest in securities-based crowdfunding transactions up to certain amounts, limiting the amounts an issuer can raise under the exemption and requiring issuers to disclose certain information relating to the company and the securities being offered. The rules also create a regulatory framework for the intermediaries that issuers are required to use in crowdfunding transactions.
The rules were certainly drafted in the spirit of offering small businesses easier access to capital. However, in practice, it remains to be seen whether compliance with the crowdfunding exemption is a feasible and worthwhile endeavor for the average small company. The new rules will likely involve substantial cost and effort for the issuers wishing to take advantage of the exemption, as a result of the investor protection requirements included in the JOBS Act, and reliance on the exemption is subject to numerous limitations found in the regulations. The limitations to the crowdfunding exemption include:
Limitation on the Amount an Issuer Can Raise. The amount an issuer can raise under the new rules is limited to an aggregate amount of $1 million in any 12-month period. Capital raised by an issuer using other registration exemptions will not be included in this $1 million limit, provided the issuer complies with all requirements of such other applicable exemptions.
Limitation on Amount Persons May Invest. An investor may only invest a limited amount of money in all exempt crowdfunding transactions of all issuers during a 12-month period, based upon the income and net worth of the investor. If an investor’s net worth or annual income is less than $100,000, the limit is the greater of $2,000 or five percent of the lesser of the investor’s annual income or net worth. If an investor’s annual income and net worth are both $100,000 or more, the limit is 10 percent of the lesser of the investor’s annual income or net worth, subject to a maximum amount of $100,000 that may be invested.
Required Use of Intermediary Platform. An offering made in reliance on the crowdfunding exemption must be made through an Internet website or other similar electronic medium accessible to the public, run by a registered broker or of a registered funding portal. Only one intermediary may be used for a crowdfunding transaction, and the offer must be made exclusively through the intermediary’s Internet website or other similar electronic medium.
Offering Disclosure Requirements. An issuer relying on the crowdfunding exemption must file a specific Crowdfunding Offering Statement with the SEC prior to the commencement of the offering and must provide certain prescribed information to investors and to the intermediary used in the offering. This offering statement must be amended and supplemented by progress updates throughout the offering as the issuer hits certain percentage thresholds of the targeted offering amount. In addition to general information surrounding the details of the issuer’s business operations, and the offering specifically, the required disclosures also specify certain procedural requirements that must be used in the offering:
- If the investment commitments received by an issuer in the offering do not equal or exceed the target offering amount at the offering deadline, no securities can be sold in the offering, investment commitments must be cancelled and committed funds must be returned.
- Investors may cancel an investment commitment at any time until 48 hours before the deadline specified in the offering statement. If an issuer reaches the target offering amount prior to the specified deadline, it may close the offering early, but only if it provides five business days’ advance notice of the accelerated deadline.
In addition to the specific limitations and requirements listed above, offerings under Regulation Crowdfunding are subject to restrictions on advertising, ongoing disclosure obligations, bad actor disqualification, and other limitations. Additionally, securities issued in reliance on the crowdfunding exemption are subject to resale restrictions, and may not be transferred by any purchaser during a one-year period after the securities are issued, except for transfers to limited specified parties.
Regulation Crowdfunding was adopted with the right intentions. However, an offering under the new rules is still no simple matter, and will require a great deal of forethought, planning and organizational execution. It remains to be seen how useful Regulation Crowdfunding will be, given all of its requirements and inherent limitations. Additionally, since companies will not even be able to take advantage of the exemption without the use of a third party intermediary platform run by a registered broker, the new regulations also leave potential issuers at the mercy of these third party intermediaries, which have yet to even be established. Regulation Crowdfunding was published in the Federal Register on November 16, 2015, and will become effective on May 16, 2016. In the meantime, companies planning to take advantage of the new rules should pay attention to the emergence of registered intermediary platforms, and consult with counsel to ensure that any future offerings in reliance on Regulation Crowdfunding will comply with all of the limitations and requirements found in the new rules.