One of the more publicized provisions of the 2012 Jumpstart Our Business Startups Act directed the U.S. Securities & Exchange Commission to establish rules allowing companies to use crowdfunding to raise capital in an exempt securities offering. The SEC’s new rules, referred to as Regulation CF and issued more than two years ago, were finalized on Oct. 30 and will become effective next May.
One of the more publicized provisions of the 2012 Jumpstart Our Business Startups Act directed the U.S. Securities & Exchange Commission to establish rules allowing companies to use crowdfunding to raise capital in an exempt securities offering. The SEC’s new rules, referred to as Regulation CF and issued more than two years ago, were finalized on Oct. 30 and will become effective next May.
The rule allows issuers to raise up to $1 million in debt or equity financing in a 12-month period, including sales to nonaccredited investors. All crowdfunded offerings must be made through an intermediary that is either a registered broker-dealer or a “funding portal.” Regulation CF permits limited advertising of the offering.
Individual investors are limited, during any 12-month period, to invest in the aggregate of crowdfunded offerings up to the following limits:
- If either the investor’s annual income or net worth is less than $100,000, then the greater of $2,000 or 5 percent of the lesser of annual income or net worth; or
- If both annual income and net worth equal or exceed $100,000, then up to 10 percent of the lesser of income or net worth.
Issuers are required to make certain disclosures prior to the offering. While the requirements are not terribly burdensome when compared to those of reporting companies, smaller issuers should factor in the compliance costs when considering reliance on the exemption. The disclosures include basic information such as the planned use of proceeds of the offering, the price per share and targeted offering size, the issuer’s business and financial condition and risk factor disclosures. Issuers are required to disclose financial statement information, and audited financials are generally required for offerings exceeding $500,000.
Crowdfunded offerings are required to be sold either by registered brokers or through funding portals that are registered with the SEC. An issuer is not permitted to raise funds through its own website. Funding portals must file a separate form to register with the SEC in addition to joining a national securities association, which would be FINRA. Each issuer is required to conduct its offering exclusively through a single platform.
Funding portals are required to provide educational materials to investors describing the process for the offering, the types of securities sold and related risks, restrictions on resale of the securities, investment limitations and compensation paid to promoters of the offering. Additionally, portals must monitor participants so that no investor exceeds the individual investor limit on crowdfunded offerings.
The primary upside for issuers is that the new rules allow them to benefit from the broad reach of the Internet in locating investors given that exempt offerings have historically limited any advertising or solicitation activities. The exemption also allows participation by nonaccredited investors. Along with other changes implemented by the JOBS Act, small companies have an array of new (or otherwise improved) choices when raising capital. The regulation pre-empts state registration requirements, meaning that an issuer can rely on the exemption across the country.
The good comes with some bad, however, as some aspects of the regulation may be particularly daunting for small issuers. For most private companies, the prospect of having a large number of small investors is not particularly enticing. This is certainly the case with equity investments that would grant each of those investors voting rights under applicable state law. For this reason, many commentators believe that the crowdfunding rules will either discourage smaller companies or otherwise lead to a disproportionate number of (nonvoting) debt offerings through funding portals.
The initial and continuing disclosure requirements must also be considered by issuers. Most private companies do not have audited financial statements, including many of those that have raised capital through other exempt offering provisions. Requiring a company that is raising only $500,001 to have audited financial statements could lead to only the very smallest of companies using the crowdfunding exemption.
Lastly, the rules permit an investor to cancel its commitment up to 48 hours prior to the issuer’s stated offering deadline. This provision is intended to permit an investor to “reconsider” his or her investment decision “with the benefit of the views of the crowd.” The SEC anticipates that crowd participants will develop a forum on the portal to communicate their thoughts on the merits of the investment.