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Equity Crowdfunding for Everyone

Raising money is hard work, but the new equity crowdfunding rules (Regulation CF) should make it easier for the entrepreneur with a compelling story to raise capital online. The Securities and Exchange Commission (SEC) has implemented Title III of the JOBS Act making it possible for smaller companies to offer and sell securities through crowdfunding. The new rules became effective May 16, 2016.

Equity crowdfunding online has been on the rise over the years, but equity-based crowdfunding for projects seeking unaccredited investors will be allowed for the first time. These new crowdfunding rules will give small businesses and start-ups an additional avenue to raise capital from “ordinary” investors, and permit everyday people to invest in securities-based crowdfunding transactions, subject to certain investment limits. The rules also impose disclosure requirements on issuers for certain information about their business and securities offering, and require issuers to raise capital through an SEC-registered intermediary, either a broker-dealer or a funding portal.

The rules may see a significant reduction in the costs of raising capital through equity crowdfunding, in that:

• The issuer must provide financial statements reviewed by a public accountant independent of the issuer, for capital raise of more than $500k but less than $1,070,000.
• The issuer must provide audited financial statements for capital raise of more than $1,070,000.
• The SEC periodically updates these thresholds for inflation.

Fundraising Limits

The equity crowdfunding rules limit the amount of money a company can raise, or an individual investor can invest, in a 12-month period, as follows:

• A company can raise a maximum aggregate amount of $5 million.
• An investor with an annual income or net worth less than $124,000 can invest a maximum aggregate amount $2,500 or 5% of the lesser of their annual income or net worth.
• An investor with an annual income or net worth greater than $124,000 can invest up to 10% of the lesser of their annual income or net worth.
• The aggregate amount of securities a company sells to an individual investor through all crowdfunding offerings may not exceed $124,000.

Foreign Businesses

Non-US companies generally are not eligible to use this crowdfunding exemption. The foreign company may establish a US-based subsidiary that conducts the crowdfunding offering.

Disclosure by Companies

Companies opting to rely on these rules must file certain information about their businesses with the SEC and make them available to investors. These disclosures are required of companies to help provide transparency to the investors. The information to be disclosed include:

• The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount;
• The company’s financial condition, including, financial statements – that may include information from the company’s tax returns;
• A description of the business and the use of proceeds from the offering;
• Information about officers and directors as well as owners of 20% or more of the company; and
• File an annual report with the SEC and provide it to investors.

Crowdfunding Platforms

A company relying on these new rules will be required to conduct its offering exclusively through one funding portal at a time.

Each of these intermediary platforms will be required to, among other things:

• Provide investors with educational materials that explain the process for investing on the intermediary’s platform, the types of securities being offered, resale restrictions, investment limits, and information regarding investment risks and related matters;
• Take certain measures to reduce the risk of fraud, such as, conducting a background check, including regulatory enforcement history, on each company offering securities on the intermediary’s platform and on each company’s directors, officers and principal stockholders; and
• Provide disclosure to investors about the compensation the funding portal receives.

Because a crowdfunding portal is not registered as a broker-dealer, it cannot solicit securities purchases, offer investment advice, or handle investor funds or securities. In addition, these crowdfunding platforms are prohibited from engaging in certain other activities, such as:

• Providing access to their platforms to companies that they have a reasonable basis for believing have the potential for fraud or other investor protection concerns;
• Having a financial interest in a company that is offering or selling securities on its platform unless the intermediary receives the financial interest as compensation for the services, subject to certain conditions; and
• Compensating any person for providing the intermediary with personally identifiable information of any investor or potential investor.

Other Limitations

Except for a tombstone ad, no solicitation of a crowdfunding offering is permitted outside the intermediary’s platform. A crowdfunding offering will not be integrated with another offering made concurrently by the issuer, but could impact whether conditions to a concurrent exempt offering have been satisfied.  For example, a company conducting a private placement and crowdfunding offering concurrently would have to determine that private placement investors hadn’t been solicited by the crowdfunding.