SEC Crowdfunding Rules Are in Effect
In recent years, crowdfunding websites like Kickstarter and GoFundMe have become a popular way for people to solicit charitable contributions or raise money for projects. Now, companies can use crowdfunding for a whole new purpose: to offer and sell securities to the investing public.
On May 16, new Securities and Exchange Commission rules authorizing equity crowdfunding took effect. The rules, titled Regulation Crowdfunding, implement requirements of the 2012 Jumpstart Our Business Startups Act, or JOBS Act, and allow private companies to offer and sell through crowdfunding offerings up to $1 million of securities to unaccredited investors over a 12-month period, under certain conditions. The change was meant to allow anyone the ability to invest in startups, something that has traditionally been reserved for the elite few. For startups, it provides another fundraising avenue, a benefit particularly for those unable to obtain seed financing from angel or venture capital investors.
In order to raise money under the new rules, companies must offer crowdfunding investments exclusively through an online platform (i.e., website or mobile app) operated by a broker-dealer or funding portal registered with the SEC. Prior to commencing a crowdfunding offering, the issuer must file offering documents with the SEC and the intermediary facilitating the offering. These documents must disclose, among other things:
- information about officers, directors, and owners of 20 percent or more of the company's stock;
- a description of the issuer’s business and the use of proceeds from the offering;
- the price to the public of the securities or the method for determining the price;
- the target offering amount and the deadline to reach the target offering amount;
- whether the issuer will accept investments in excess of the target offering amount;
- certain related-party transactions; and
- a discussion of the issuer’s financial condition and financial statements.
The financial information an issuer is required to disclose depends on the size of the offering and whether this is the first time the company is using Regulation Crowdfunding. The requirements are as follows:
Issuers offering $100,000 or less: Financial statements of the issuer and certain information from the issuer’s federal income tax returns (total income, total taxable income and total tax). This information must be certified by the principal executive officer. An audit is not required, however, if the financial statements have been audited, they must be provided. In that case, certification by the executive officer is not required.
Issuers offering more than $100,000 but not more than $500,000: Financial statements reviewed by a public accountant. Again, an audit is not required, but if the financial statements have been audited, they must be provided.
Issuers offering more than $500,000: If it is the first time the issuer has relied on Regulation Crowdfunding, it must provide financial statements reviewed by a public accountant, unless audited financial statements are available. Companies that have previously sold securities under Regulation Crowdfunding are required to provide audited financial statements.
In addition, companies must file an amendment with the SEC to disclose any changes to offerings that have not been completed. The issuer must also provide updates after reaching 50% and 100% of its target offering amount, and also file an annual report with the SEC and post the report on its website.
Any investor, accredited and non-accredited, is able to participate in a crowdfunding offering. But there are limits on the amount of securities the investor can purchase in a 12-month period in the aggregate across all crowdfunded offerings, depending on net worth and annual income.
- If either annual income or net worth is less than $100,000, an individual can invest up to the greater of either $2,000 or 5 percent of the lesser of their annual income or net worth.
- If an individual’s annual income and net worth are both more than $100,000, they can invest up to 10 percent of their income or net worth, whichever is less. The amount invested cannot exceed $100,000.
Investors can calculate their annual income and net worth jointly by including their spouse’s income and assets. In that scenario, each of their crowdfunding investments together cannot exceed the limit that would apply to an individual investor that income or net worth level. Generally, issuers can rely on the crowdfunding intermediary to determine whether an investor is within its limit.
There are other rules associated with crowdfunding. With limited exceptions, a company cannot advertise the offering outside the intermediary’s platform. Also, all crowdfunding offers and sales must be conducted through a single crowdfunding intermediary, and exclusively through the intermediary’s platform. While an issuer can compensate someone to promote the offering, the promoter must identify themselves as such in all communications to existing and potential investors.
In addition, securities purchased in a crowdfunding offering cannot be resold for one year, unless they are transferred to the issuer, an accredited investor, or a family member. Holders of crowdfunded securities don't count toward the minimum stockholder threshold that would require an issuer to register its securities with the SEC under Section 12(g) of the Exchange Act, as long as certain requirements are met.
Issuers that are not eligible to use the new crowdfunding rules include:
- foreign companies;
- SEC reporting companies (those that are subject to reporting requirements under the Securities Exchange Act of 1934);
- certain investment companies;
- those subject to disqualification rules, (modeled on the bad actor rules under Rule 506 of Regulation D);
- issuers that have failed to comply with the rule's annual reporting requirements during the two years immediately preceding the filing of a crowdfunding offering statement; or
- issuers with no specific business plan or whose business plan is to engage in a merger or acquisition with an unidentified company or companies.
Although a crowdfunding offering will not be integrated with other offerings, it could impact whether conditions in a concurrent exempt offering have been satisfied. Take, for instance, a company that conducts a crowdfunding offering at the same time as a private placement. The company would have to make sure the private placement investors have not been solicited by the crowdfunding. There are also a series of rules for intermediaries, which is separately discussed here.