On October 30, 2015, the SEC finally released its final crowdfunding regulations, years after its deadline. The final rules, Regulation Crowdfunding, permit individuals to invest in securities-based crowdfunding transactions subject to certain investment limits. The rules also limit the amount of money a company can raise using the crowdfunding exemption, impose disclosure requirements on issuers for certain information about their business and securities offering, and create a regulatory framework for the broker-dealers and funding portals that facilitate the crowdfunding transactions.
Here are the highlights of the Regulation Crowdfunding rules:
- Permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period;
- Permit individual investors, over a 12-month period, to invest in the aggregate across all crowdfunding offerings up to:
o If either their annual income or net worth is less than $100,000, than the greater of:
– $2,000 or
– 5 percent of the lesser of their annual income or net worth.
o If both their annual income and net worth are equal to or more than $100,000, 10 percent of the lesser of their annual income or net worth; and
o During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.
Besides the limitations above, all deals relying on the new rules would be required to take place through an SEC-registered intermediary, either a broker-dealer or a funding portal.
Companies using Regulation Crowdfunding would have to engage in certain types of investor disclosure as well, which will increase compliance costs and efforts. Below are highlights of items that need to be disclosed by companies in formal documents and filings under the new rules:
- 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 discussion of the company’s financial condition;
- Financial statements of the company that, depending on the amount offered and sold during a 12-month period, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. A company offering more than $500,000 but not more than $1 million of securities relying on these rules for the first time would 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;
- A description of the business and the use of proceeds from the offering;
- Information about officers and directors as well as owners of 20 percent or more of the company; and
- Certain related-party transactions.
Securities professionals are actively debating the merits of the new Regulation Crowdfunding rules. One thing is certain, however. Many professional or semi-professional investors (for example, accredited angel investor groups) are cautious about recommending the new Regulation Crowdfunding strategy to companies who will later seek venture capital to engage in equity crowdfunding under the new regulations. Here are some of the reasons why some of these groups are cautious about recommending this strategy to companies
- Messy cap tables—with lots of small, individual investors, your cap table runs the risk of looking very messy and difficult to manage.
- Complex Compliance and High Costs—the new rules for Regulation Crowdfunding mandate heightened disclosure to your investors, so you can expect to pay more in legal and accounting fees to meet these new rules if you choose to engage in Regulation Crowdfunding rounds. In addition, the more distant the relationship with these new investors, the more risk there might be for securities litigation relating to inadequate disclosure.
- Unknown risks—more than anything, VCs and formal angel groups are concerned with investing into a company that has shareholders unknown to management and themselves. If a shareholder who invests in a crowdfunding round decides to be difficult and sue or harass management over the company’s performance, then there is a risk to the capital investors that their money will go to paying to deal with these troublesome shareholders.
Crowdfunding can be a great tool for some companies to use to raise their profile and obtain needed capital. Certain types of equity crowdfunding with equity investors have been used by our clients successfully to raise funds. However, before you start the process, it is a good idea to consult with experienced securities professionals that can help you determine if it is a good fit for your financing strategy.
By Mark Graffagnini, President, Graffagnini, L.C. Mark is an attorney and advisor who represents investors and companies in financing transactions, general corporate matters, M&A deals and securities reporting.
Disclaimer: This post discusses general issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Graffagnini, L.C. and the author expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.