On October 30, 2015, the Securities and Exchange Commission (SEC) approved finalized rules for investment crowdfunding for nonaccredited investors in accordance with requirements of Title III of the Jumpstart Our Business Startup (JOBS) Act. Companies will be permitted to raise a maximum aggregate of $1 million through crowdfunding offerings in a 12-month period. The rules were approved by a 3-1 vote despite concerns about inadequate mom and pop investor protections. The final rule has several revisions from the 2013 proposal, reducing some cost and complexity. The biggest change is that certain first-time issuers wouldn t have to submit audited financial statements. The final rules will be effective 180 days after publication in the Federal Register. Crowdfunding uses the Internet and social media to solicit small sums from large numbers of people. Companies and individuals use crowdfunding to raise money for products, projects or nonprofit ventures through platforms such as Kickstarter, Indiegogo, CircleUp and icrowd. Crowdfunding platforms or portals act as intermediaries between companies seeking money and investors. The new rules allow individuals to purchase securities in crowdfunding offerings subject to certain limits, require companies to disclose certain information about their business and securities offering and create a regulatory framework for the intermediaries facilitating crowdfunding transactions. Currently, only accredited investors, individuals earning more than $200,000 per year (or $300,000 with spouse), those with a net worth above $1 million or qualified institutional buyers can invest in startups and other private offerings online via crowdfunding. Investor Requirements The law limits how much investors can put into these offerings. Under the final rule, any investor could not exceed either of these limits over a 12-month period: If either their annual income or net worth is less than $100,000, the greater of $2,000 or 5 percent of the lesser of their annual income or net worth If both their annual income and net worth are at least $100,000, 10 percent of the lesser of their annual income or net worth During the 12-month period, the aggregate amount of securities sold to an individual investor through all crowdfunding offerings may not exceed $100,000. Investor Annual Income Investor Net Worth Examples of Investor Limits Calculation Investment Limit $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 $1,200,000 ($120,000), subject to $100,000 cap $100,000 Crowdfunded securities cannot be resold for one year. It s unclear how these securities would be transferred in the secondary market after the restriction period, since there currently are few resale marketplaces established.
In general, holders of these securities wouldn t count toward the 2,000-investor limit that requires a company to register with the SEC 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. All transactions relying on the new rules would be required to take place through an SEC-registered intermediary either a broker-dealer or a funding portal. Issuer Requirements The new crowdfunding rules permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period. Certain companies wouldn t be eligible to use the exemption, including: Non-U.S. companies Exchange Act reporting companies Certain investment companies Companies that have failed to comply with the annual reporting requirements during the two years immediately preceding the filing of the offering statement Companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies Disclosures Companies relying on the new rules to conduct a crowdfunding offering must file certain information with the SEC and provide this information to investors and the intermediary facilitating the offering. This information includes: The security price or 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 in accordance with generally accepted accounting principles (GAAP) for 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 Companies raising between $100,000 and $500,000 must have their financial statements reviewed, but not audited, by an accountant Companies raising more than $500,000 must have financial statements audited by an accountant In a substantial change from the proposal, 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. This was in response to a number of comments that the proposed audit requirement would be too costly and burdensome for issuers in comparison to the size of the offering proceeds. 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 Certain related-party transactions 2
In addition, companies relying on the crowdfunding exemption would be required to file an annual report with the SEC and provide it to investors. Issuers offering securities under the crowdfunding rules will be considered public business entities as defined by the Financial Accounting Standards Board and, therefore, ineligible to rely on any alternative accounting or reporting standards for nonpublic business entities. The SEC retains the authority to determine whether such issuers would be permitted to rely on the developing nonpublic business entity standards. The final rules don t allow Regulation Crowdfunding issuers to use the alternatives available to nonpublic business entities under U.S. GAAP in the preparation of their financial statements. Crowdfunding Platforms Crowdfunding intermediaries won t have to register as broker-dealers. However, intermediaries that don t register as broker-dealers are prohibited from: Providing investment advice or making recommendations Soliciting purchases, sales or offers to buy securities Holding, managing, possessing or otherwise handling investor funds or securities Compensating promoters and other persons for solicitations or based on the sale of securities All funding portals must register with the SEC and become a member of a national securities association (currently, the Financial Industry Regulatory Authority, or FINRA). Funding portals won t be members of the Securities Investor Protection Corporation (SIPC) and their customers won t receive SIPC protection. In addition, the final rules don t subject funding portals to minimum net capital requirements. Portals can register starting January 29, 2016. A company relying on the rules will be required to conduct its offering exclusively through one intermediary platform at a time. Intermediaries are required to: Provide investors with educational materials that explain the process for investing on the platform, the types of securities being offered and information a company must provide to investors, resale restrictions and investment limits Take certain measures to reduce the risk of fraud, including having a reasonable basis for believing a company complies with Regulation Crowdfunding and the company has established means to keep accurate records of securities holders Make information a company is required to disclose available to the public on its platform throughout the offering period and for a minimum of 21 days before any security may be sold in the offering Provide communication channels to permit discussions about offerings on the platform Provide disclosure to investors about compensation the intermediary receives Accept an investment commitment from an investor only after that investor has opened an account Have a reasonable basis for believing an investor complies with the investment limitations Provide notices to investors once they have made investment commitments and confirmations at or before completion of a transaction Comply with maintenance and transmission-of-funds requirements Comply with completion, cancellation and reconfirmation of offerings requirements 3
The rules also would prohibit intermediaries from engaging in certain 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 Compensating any person for providing the intermediary with personally identifiable information of any investor or potential investor The SEC notes the fees charged in a crowdfunding offering can be significantly higher on a percentage basis relative to the underwriting fees for registered offerings, which range from as much as 7 percent for initial public offerings to less than 1 percent for certain bond issuances. SEC s Estimated Intermediary Fees Offering Size Intermediary Fee (% of Offering Size) < $100,000 5-15% $100,000 - $500,000 5-10% $500,000 - $1,000,000 5-7.5% Proposed Amendments The SEC also considered other proposed amendments to some of its older rules governing intrastate equity sales. During the three-year delay in approving federal crowdfunding rules, more than 25 states have adopted their own rules to let local businesses raise capital within their respective states. Securities Act Rule 147 The SEC adopted Rule 147 in 1974 as a safe harbor to a statutory intrastate exemption that was included in the Securities Act upon its adoption in 1933. Market participants and state regulators have indicated the combined effect of the statutory limitation on offers to persons residing in the same state or territory as the issuer and the prescriptive eligibility requirements of Rule 147 limit the availability of the exemption for companies that would otherwise conduct intrastate offerings. Rule 147 would be revamped as a new exemption, allowing intrastate offerings to raise up to $5 million per year, and would eliminate the ban on advertising that might reach people outside of the state where the offering is being conducted and loosen the strict requirements defining an in-state company. These changes are intended to help coordinate intrastate crowdfunding. Regulation D, Rule 504 The Rule 504 changes also would make it easier to coordinate equity crowdfunding raises across neighboring states. The proposed amendments would increase the aggregate amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million and disqualify certain bad actors from participation in Rule 504 offerings. Additional Resources Companies also should consider several other capital alternatives under different provisions of the JOBS Act. The new Reg A+ regulations may be a more attractive alternative to crowdfunding. See a comparison in Appendix A. 4
BKD has prepared several papers on the JOBS Act and will continue to monitor updates. These resources are collected in the Hot Topics section of bkd.com. For more information, contact your BKD advisor. Contributor Anne Coughlan Director 317.383.4000 acoughlan@bkd.com 5
Appendix A Dollar limit (in 12-month period) Periodic SEC reporting Audited financial statements Comparison of Small-Issue Exemptions Regulation A Tier 1 Regulation A Tier 2 Crowdfunding $20 million $50 million $1 million None No, unless prepared for other purposes Annual report Semiannual reports Current report Special financial reports Yes Can use either U.S. GAAS or PCAOB standards Annual disclosure and financials None if < $100,000 Reviewed if $100,000 - $500,000 Audited > $500,000 (review permitted for first-time offering if < $1 million Can use either U.S. GAAS or PCAOB standards Investor verification None Self-certification Self-certification Individual investor limits Testing the waters Offering statement None Yes Solicitation materials to be filed with first offering statement 48 hours prior to first sale Yes Includes a description of business, management and properties; risk factors; financial information; capitalization; and use of proceeds For nonaccredited investors, 10 percent of greater of income or net worth (not applicable for securities to be listed on a national securities exchange) Yes Solicitation materials to be filed with first offering statement 48 hours prior to first sale Yes Similar to Tier 1 with some changes to existing forms $2,000 minimum 5 percent of income or net worth below $100,000 10 percent above $100,000 $100,000 maximum No SEC prefiling required Offering documents must include information about officers and directors, business description, use of proceeds, price target offering amount, related-party transactions and issuer s financial condition State Security Law Pre-emption Advertising/general solicitation SEC qualification and state approval No Coordinated review SEC approval Yes SEC filing required; no SEC approval needed Yes, but must make filing in home state and any state with greater than 50 percent of crowdfunders Unrestricted Unrestricted Limited to notices; all must occur on Internet 6