By Benji Jones and Alex Bowling
Over three years after the passage of the landmark Jumpstart Our Business Startups Act (JOBS Act), in late October 2015 the Securities and Exchange Commission (SEC) adopted Regulation Crowdfunding, a new regulatory framework that implements the “crowdfunding” exemption under Title III of the JOBS Act. Crowdfunding[1] is a growing and developing method of raising capital using the Internet. Title III of the JOBS Act (which created the Section 4(a)(6) exemption from registration under the Securities Act of 1933, as amended (the Securities Act), to enable crowdfunding) was designed to help provide start-ups and small businesses with capital by making relatively low dollar offerings of securities less costly.
Regulation Crowdfunding, which became effective on May 16, 2016 for companies looking to raise capital (or “issuers”), imposes restrictions on issuers as well as on the “crowdfunding intermediaries” that must be used to conduct such offerings.[2] The SEC’s crowdfunding regulations are detailed, complex and lengthy (encapsulated in a nearly 700 page adopting release). We summarize below the requirements imposed on issuers.
OVERVIEW OF REGULATION CROWDFUNDING FOR ISSUERS
Regulation Crowdfunding (or Regulation CF), among other things, enables individuals to purchase securities in crowdfunding offerings subject to certain limits, requires companies to disclose certain information about their business and securities offering and creates a regulatory framework for the intermediaries facilitating crowdfunding transactions. More specifically, the rules:
- Permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period;
- Permit individual investors (without regard to accredited status) to invest an aggregate in all crowdfunding offerings in a 12-month period of up to:
o If either their annual income or net worth is less than $100,000, then the greater of:
- $2,000 or
- 5% of the lesser of their annual income or net worth; or
o If both their annual income and net worth are equal to or more than $100,000, 10% of the lesser of their annual income or net worth, not to exceed $100,000.
Securities purchased in a crowdfunding transaction generally will not be able to be resold for one year. Holders of these securities will not count toward the threshold that requires a company to register its securities under Section 12(g) of the Securities Exchange Act of 1934, as amended (the Exchange Act), if the company is current in its annual reporting obligations, retains the services of a registered transfer agent and has less than $25 million in total assets as of the end of its most recently completed fiscal year.
REQUIREMENTS FOR CROWDFUNDING OFFERINGS
Ineligible Companies. Certain types of issuers may not rely on the Section 4(a)(6) crowdfunding exemption, including (among others) non-U.S. companies, Exchange Act reporting companies, certain investment companies, companies that are subject to disqualification, companies that have failed to comply with the annual reporting requirements under Regulation CF and companies that have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies.
Offering Intermediary. All Regulation CF offerings and associated activities must occur over the Internet or other similar electronic medium that is accessible to the public, through a SEC-registered intermediary, either a broker-deal or a funding portal. Issuers are allowed to use only one intermediary to conduct a crowdfunding offering.
Disclosure Requirements. An issuer offering securities pursuant to Regulation CF must file specified disclosures with the SEC, provide these disclosures and certain financial information to the relevant broker or funding portal and make these disclosures available to actual and potential investors.
Form C. The SEC has created a new “Form C,” which is designed to enable issuers to satisfy initial (and ongoing) disclosure requirements.[3] Form C utilizes the standard eXtensible Markup Language (XML) format for certain information, and issuers will either customize the presentation of the rest of their disclosures or utilize a question and answer format and file those disclosures as exhibits to the Form C. Among other things, the Form C must disclose:
- 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;
- A description of the business and the use of proceeds from the offering;
- A narrative discussion of the company’s financial condition;
- Financial statements of the company, as described in more detail below;
- Information about officers and directors as well as owners of 20% or more of the company; and
- Certain related-party transactions.
Financial Information. As required by the JOBS Act, the SEC’s rules require an issuer to provide certain financial information to investors participating in a crowdfunding offering. Generally, issuers must provide U.S. GAAP financial statements for the two most recently completed fiscal years (or shorter period during which the issuer has been operating); however, the detail of review depends on the amount of money to be raised in the offering, as follows:
- Offerings of $100,000 or less: The issuer must provide U.S. GAAP financial statements and information from its filed income tax return for the most recently completed fiscal year, if any, in both cases certified by the issuer’s principal financial officer.
- Offerings of between $100,000–$500,000: The issuer must provide U.S. GAAP financial statements reviewed by an independent public accountant and be accompanied by the accountant’s review report.
- Offerings over $500,000: The issuer must provide U.S. GAAP financial statements audited by an independent auditor and be accompanied by the audit report. However, an issuer offering more than $500,000 relying on these rules for the first time will be permitted to provide reviewed rather than audited financial statements, unless financial statements of the company are available that have been audited by an independent auditor.
Restrictions on Advertising and Communications. Issuers in a crowdfunding offering are only permitted to advertise the “terms of the offering” through a special notice (similar to “tombstone ads” under Rule 134 of the Securities Act for public offerings). The terms of the offering include: the amount of securities offered; the nature of the securities; the price of the securities; and the closing date of the offering period. In addition to the terms, such advertisements may only include certain limited factual information about the company (including the company’s name and contact information, the offering intermediary and a brief description of the company’s business) and must direct readers to the intermediary’s platform for the offering for any further information. These limitations on advertising during the offering period apply only when the advertisement includes any of the terms of the offering. The issuer can continue to advertise its products or services in the ordinary course of business as long as such advertisement does not include the offering terms listed above. The issuer may also make other communications during a crowdfunding offering that do not refer to the terms of the offering without limitation on the content of the communication, subject to other applicable SEC rules governing publicity and offers during securities offerings. The rules also permit, within certain limitations, an issuer to communicate with prospective investors through communication channels provided by the intermediary on the intermediary’s platform.
Please contact Heyward Armstrong or Carl Patterson if you have any questions or would like to learn more.
[1] Although the meaning for the term varies with context, “crowdfunding” as used in this Alert refers solely to securities offerings made in reliance on Section 4(a)(6) of the Securities Act.
[2] The new rules permit the Internet-based platforms to facilitate the offer and sale of securities without having to register with the SEC as brokers (although registration as a “funding portal” is required).
[3] A Form C (or related form) must be filed with the SEC on EDGAR: (1) before the commencement of a crowdfunding offering; (2) during the pendency of a crowdfunding offering to report progress toward the funding goal and, when applicable, certain changes to the offering or updates (unless the intermediary provides frequent updates regarding the issuer’s progress towards its goal); (3) annually after completing a crowdfunding offering; and (4) at the conclusion of Form C reporting obligations.