On Friday, October 30, 2015, the U.S. Securities and Exchange Commission (SEC) finally adopted final rules for implementation of Title III of the JOBS Act, which allows companies to offer and sell its securities through the use of crowdfunding. The final rules are the culmination of a three-year process of proposed rules and delays.
Securities-based crowdfunding allows eligible startups and small businesses to raise capital by pooling small investments from multiple people around the country. Specifically, this type of crowdfunding seeks to alleviate the funding gap and accompanying regulatory concerns faced by startups and small businesses looking to raise capital in relatively low dollar amounts. The SEC has had to balance easing access to capital with its mission to protect investors and require adequate disclosure about a company’s operations. Therefore, although the JOBS Act seeks to make it easier for companies to raise capital, the final rules provide for certain restrictions and disclosures.
The new crowdfunding rules, approved 3-1 by the SEC, now enables everyday citizens, or those non-accredited investors who generally make less than $200,000 per year and have a net worth less than $1 million, to invest and purchase securities of early-stage companies (subject to certain limits). The final rules also require companies to disclose certain information about their business and securities offerings, and create a regulatory framework for crowdfunding portals or crowdfunding intermediary websites such as Kickstarter or Indiegogo.
What companies are eligible to issue equity via crowdfunding?
Specifically, the final rules allow eligible startups and small businesses to raise up to $1 million via standard broker-dealers or registered crowdfunding portals within a 12-month period. Offerings may only be conducted exclusively through one portal platform at a time. Companies not eligible to sell its securities via crowdfunding include:
- Non-U.S. companies,
- Exchange Act reporting companies,
- Certain investment companies,
- Companies subject to disqualification under the crowdfunding regulations,
- Companies that have failed to comply with annual reporting requirements of the crowdfunding regulations during the two-years immediately preceding the filing of an offering statement, and
- Companies with no specific business plan or that have indicated they intend to engage in a merger or acquisition with unidentified buyers or sellers.
How much may be invested?
Individual investors, whether accredited or non-accredited, are limited on the aggregate amount they may invest over a 12-month period. Investors may invest, across all crowdfunding offerings, up to:
- The greater of $2,000 or 5% of the lesser of their annual income or net worth if either their annual income or net worth is less than $100,000, or
- 10% of the lesser of their annual income or net worth if both their annual income and net worth are $100,000 or more.
The SEC illustrates such rules as provided below:
|Investor Annual Income||Investor
(across all offerings)
|$30,000||$105,000||Greater of $2,000 or 5% of $30,000 ($1,500)||$2,000|
|$150,000||$80,000||Greater of $2,000 or 5% of $80,000 ($4,000)||$4,000|
|$150,000||$100,000||10% of $100,000 ($10,000)||$10,000|
|$200,000||$900,000||10% of $200,000 ($20,000)||$20,000|
|$1,200,000||$2,000,000||10% of $1.2 million ($120,000), subject to $100,000 cap||$100,000|
During the 12-month investment period, an individual investor may not purchase more than $100,000 worth of securities (through all crowdfunding offerings) and must generally hold all securities purchased for at least one year.
What are companies required to disclose?
The final rules provide for significant disclosures to be made by eligible companies for purposes of providing transparency to investors. Generally, eligible companies must disclose:
- The sale price of its securities (or the method of determining the price),
- The target offering amount and said target’s deadline,
- Whether the company will accept investment in excess of the target offering amount,
- A summary or discussion of the company’s financial condition,
- A description of the business and the use of proceeds from the offering,
- Information about officers, directors and owners of 20% of more of the company,
- Certain related-party transactions
- An annual report with the SEC and investors.
Most notably, the final rules do not generally require companies to disclose audited financial statements, which was initially viewed as a potentially costly proposal by the SEC. Companies are, however, required to disclose:
- For offerings of $100,000 or less: tax information (in lieu of filed tax returns) and financial statements certified by the company’s executive officer.
- For offerings more than $100,000 but not more than $500,000: financial statements reviewed by an independent accountant.
- For offerings more than $500,000:
- If the offering is a first-time offering not more than $1 million: financial statements reviewed by an independent public accountant.
- If the offering is not a first-time offering: financial statements audited by an independent accountant.
If, however, an independent accountant has previously audited the company’s financial statements, then the company must disclose that.
May companies advertise their crowdfunding offerings?
The final rules allow companies to advertise their crowdfunding offerings and do not impose limitations on how companies distribute advertising notices. However, advertising notices must not include any more than the following information:
- A statement that the company is conducting an offering,
- The name of and link to the crowdfunding portal conducting the offering,
- The terms of the offering (amount of securities offered, nature of securities, price of securities and closing date of offering) and
- Name, address, phone number and website of the company.
Additionally, persons acting on behalf of a company (and who identify their affiliation with the company) may communicate with investors about the terms of the offering through communication channels provided by the crowdfunding portal’s platform.
Requirements of crowdfunding portals
The final rules impose several requirements and restrictions on the crowdfunding portals themselves. Such portals must register with the SEC and Financial Industry Regulatory Authority (FINRA) and provide investors with certain disclosures and education materials that explain, among other things, the process for investing on the platform, the securities being offered and company offering the securities, resale restrictions and investment limits. The SEC also now requires the portals to take measures that reduce the risk of fraud, as crowdfunding portals can be held liable for company fraud against investors.
Also, crowdfunding portals will be allowed to take equity in companies that use their platform if such equity is issued under the same terms of the company’s offering and if such equity acts as compensation for the portal’s services. All such arrangements must be disclosed.
When will the final rules be effective?
The final rules will be effective 180 days following publication on the Federal Register. Forms permitting registration with the SEC by crowdfunding portals will be effective January 29, 2016.
For more information, please contact your Michael Best attorney; Michael H. Altman at firstname.lastname@example.org or 414.225.4932; Daniel J. Gawronski at email@example.com or 608.283.0124; or Paul A. Jones firstname.lastname@example.org or 608.283.0125.