On October 30, 2015, the U.S. Securities and Exchange Commission adopted final rules permitting issuers to use crowdfunding to raise capital. The rules, which were originally proposed more than two years ago pursuant to Title III of the JOBS Act, go into effect in May 2016 as a new "Regulation Crowdfunding" and permit the sale of securities through registered broker–dealers or "funding portals" subject to a number of significant restrictions and requirements.
Regulation Crowdfunding. Upon effectiveness of Regulation Crowdfunding, issuers will be permitted to raise up to $1,000,000 in any 12-month period in one or more offerings that—unlike private offerings under Regulation D—need not be restricted in their use of general solicitation or sales to non-accredited investors1. There are, however, several significant limitations with which crowdfunding offerings must comply:
Individual Investor Limits. An individual investor, over a 12-month period, may not make aggregate investments in crowdfunding offerings exceeding the greater of $2,000 or five percent of the lesser of their annual income or net worth, unless both their annual income and net worth are equal to or more than $100,000, in which case the limit is ten percent of the lesser of their annual income or net worth, subject to an absolute maximum of $100,000 in crowdfunding investments in any 12-month period.
Certain Issuers Disqualified. Non-U.S. companies, Exchange Act reporting companies, certain investment companies, companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding for the two years immediately preceding the crowdfunding offering (see below for a discussion of these annual reporting requirements), shell companies, special purpose acquisition companies, and certain other disqualified issuers will be ineligible to rely on Regulation Crowdfunding to raise capital.
Resales of Crowdfunding Securities Remain Restricted. For a period of one year following their issuance in a crowdfunding offering, shares may not be resold without registration unless they are being transferred to the issuer, a family member (or certain estate planning vehicles or in connection with a death or divorce), or an accredited investor. It is important to note that that this restriction applies not only to the original purchaser, but to any holder of such shares during the one-year period.
Offerings Must Be Conducted Through Registered Broker–Dealers or Funding Portals. The rules do not allow for an issuer to simply set up a website and begin crowdfunding their securities. Rather, offerings must be conducted through the online platform of a registered broker–dealer or "funding portal," which are themselves subject to a specific set of registration requirements. An issuer can use only one intermediary to conduct a Regulation Crowdfunding offering, which the SEC believes would help foster the creation of a "crowd" and enable the crowd to better obtain and share information.
Minimum Information Requirements for Offerings. Crowdfunding issuers will be required to provide to investors (as well as the funding portal or broker through which they are conducting the offering) certain required information about the offering, including:
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information about the pricing, timing, and size of the offering (including how the offered securities are being valued);
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discussion of the issuer's business, financial condition (including a discussion of liquidity, capital resources, historical results of operations and any material changes or trends known to management subsequent to the period for which financial statements are provided), and planned use of proceeds;
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the terms of the securities offered and each other class of security of the issuer;
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disclosures regarding certain related party transactions2 and the issuer's officers,3 directors,4 and 20 percent beneficial owners5;
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risk factors associated with an investment in the securities, the material terms of any indebtedness of the issuer, the compensation paid to the intermediary, and certain other information, including any material information necessary in order to make the disclosures made, in light of the circumstances under which they were made, not misleading; and
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financial statements that, depending on the aggregate size of the issuer's crowdfunding offerings, will need to be either accompanied by information from the company's tax returns, reviewed by an independent public accountant, or audited by an independent auditor6 . The financial statements must be prepared in accordance with U.S. generally accepted accounting principles.
The issuer must file these disclosures with the SEC on a newly promulgated Form C, and must provide progress updates on the crowdfunding offering either through the intermediary on its online platform or by filing a Form C-U with the SEC. In addition, if there are any material changes made to the terms of the offering or previous disclosure, issuers must file the amended disclosure with the SEC on an amendment to Form C and provide the amended disclosure to investors and the intermediary. In any event, issuers must file a Form C-U with the SEC to disclose the total amount of securities ultimately sold in the offering.
Annual Reporting Requirements after Offering. Issuers that sold securities in reliance on Regulation Crowdfunding must file an annual report with the SEC within 120 days after fiscal year-end. Issuers must post the annual report on their websites. The annual report must contain the information generally required in the offering statement as described above with the exception of the offering-specific information. The financial statements contained in the annual report must be certified by the principal executive officer to be true and complete in all material respects; provided, that issuers that have available financial statements that have been reviewed or audited by an independent accountant must provide those instead. The annual reporting obligations will terminate upon the earliest to occur of: (1) the issuer has filed at least one annual report and has fewer than 300 holders of record; (2) the issuer has filed at least three annual reports and has total assets that do not exceed $10 million; (3) the issuer becomes a SEC publicly-reporting company; (4) the issuer or another party purchases all of the securities issued pursuant to Regulation Crowdfunding; and (5) the issuer liquidates or dissolves.
Advertising of Offering. Issuers are restricted in their ability to advertise the terms of the offering. Issuers may provide an advertising notice, but the notice can include no more than: (1) a statement that the issuer is conducting an offering, the name of the intermediary, and a link directing the investor to the intermediary's online platform; (2) the terms of the offering (i.e., the amount of securities offered, the nature of the securities, the price of the securities, and the closing date for the offering period); and (3) factual information about the legal identity and business location of the issuer (i.e., the issuer’s name, address, phone number and website and a brief description of the business of the issuer). The permitted notice will be similar to tombstone ads permitted under Rule 134 of the Securities Act of 1933. The final rules do not impose limits on how the issuer distributes the advertising notices. For example, the issuer could place notices in newspapers or post notices on social media sites or the issuer's own website. In addition, issuers may communicate with investors about the terms of the offering through communication channels provided by the intermediary on the intermediary’s online platform, so long as the issuer identifies itself as the issuer in all communications. The final rules do not restrict an issuer’s ability to communicate other information that might occur in the ordinary course of its business and that do not refer to the terms of the offering.
State Blue Sky Laws. Under the final rules, registration requirements under state securities laws will be preempted for securities issued in crowdfunding offerings that meet the Regulation Crowdfunding requirements. Some states, including Texas, have also adopted rules to permit purely intrastate crowdfunding offerings. (See our e-Alert on the Texas crowdfunding rules here.)
Though the final rules remain largely unchanged from the SEC's initial rule release in 2013, several technical changes have been made since the original proposal, and the rules will no doubt be refined through SEC guidance and subsequent amendments as both issuers and regulators gain experience with this new framework.
Before considering a crowdfunding offering—or any offering of securities—issuers should consult with counsel to ensure compliance with state and federal securities law requirements and to evaluate potentially superior options for private capital raising.
1In determining the dollar amount that may be sold under Regulation Crowdfunding, an issuer should not include amounts sold in other exempt offerings during the preceding 12-month period. Likewise, an offering made in reliance on Regulation Crowdfunding should not be integrated with another exempt offering made by the issuer, so long as each offering complies with the requirements of the applicable exemptions.
2Disclosure is required for related party transactions that, in the aggregate, are in excess of 5 percent of the aggregate amount of capital raised by the issuer in reliance on Regulation Crowdfunding during the preceding 12 months, including the amount the issuer seeks to raise in the current crowdfunding offering.
3An issuer must provide disclosure regarding its president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any person routinely performing similar functions. Disclosure must include the prior business experience for the prior three years.
4Disclosure must include the prior business experience for the prior three years.
5Beneficial ownership is calculated in reference to total outstanding voting securities of the issuer.
6Generally, the financial statement requirements are as follows: (1) for issuers offering $100,000 or less, certain tax information and financial statements certified by the principal executive officer to be true and complete in all material respects; (2) for issuers offering more than $100,000 but not more than $500,000, financial statements reviewed by an independent public accountant; and (3) for issuers offering more than $500,000, financial statements audited by an independent auditor, except that if the issuer is relying on Regulation Crowdfunding for the first time, financial statements reviewed by an independent public accountant; provided that if the issuer already has audited or reviewed financial statements, such audited or reviewed financial statements must be provided in lieu of the lesser financial statement disclosure requirement.
