By: Kurt Spurgeon
On May 16, 2016, companies gained an additional avenue for raising capital when the SEC rules regarding regulation equity crowdfunding became effective; however, as discussed below, due to regulatory burdens, such an offering is probably best utilized as a last resort. (See generally 17 C.F.R. Part 227). The term “crowdfunding” is defined as the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the internet. Crowdfunding has existed in one form or another for some time, although offering equity interests in companies through crowdfunding is a relatively new development.
Most people associate crowdfunding with “rewards-based crowdfunding.” In rewards-based crowdfunding, companies utilize websites such as Kickstarter to solicit investors for particular ventures, and in return the investors receive certain rewards or benefits–not equity interests. As a result, the practice does not result in the sale of a security and is not regulated by the SEC, although state and federal consumer protection laws apply. Rewards-based crowdfunding has proven a good option for small companies looking to fund particular ventures–especially when those ventures do not require raising large sums of capital.
In contrast to rewards-based crowdfunding, regulation equity crowdfunding allows companies to solicit and issue equity interests to investors–including non-accredited investors–without registering with the SEC. However, while the new regulations afford companies greater access to potential investors, the rules also impose many restrictions that may diminish the usefulness of regulation equity crowdfunding in practice. For instance, issuers may only raise $1 million in any 12 month period, and they may do so only through registered broker-dealers, or SEC approved online intermediary platforms (in contrast, certain traditional types of offerings under Rule 506 allow companies to raise unlimited amounts). In addition, there are restrictions on the amount that investors may invest. Specifically:
- Individuals with either an annual income or net worth less than $100,000 can invest up to the greater of $2,000 or 5% of the lesser of annual income and net worth; and
- Individuals with both annual income and net worth of at least $100,000 can invest up to 10% of the lesser of annual income and net worth.
Furthermore, an individual investor may only invest $100,000 over a 12 month period in offerings made under the regulation equity crowdfunding regulations. In addition to the limitations on the amounts issuing companies and investors may raise or invest, issuing companies are subject to advertising restrictions that generally limit an issuing company to providing investors a basic statement about the offering and directing the investor to the name and web address of the intermediary.
Issuing companies are also subject to extensive disclosure requirements. For instance, the issuing company must, among other things:
- Provide a list of its directors and officers and their business experience for the past 3 years.
- Provide a business plan.
- Provide company ownership and structural information.
- Identify the current number of employees.
- Identify risk factors.
- Identify certain related party transactions.
Moreover, regulation equity crowdfunding issuers are also required to provide GAAP financial statements that are reviewed by an independent public account if the issuing company is raising over $100,000, and audited financial statements if the issuing company is raising over $500,000. Furthermore, the issuing company must provide a narrative discussion of its financial condition. Issuing companies must also adhere to ongoing reporting requirements, including filing a report with the SEC and posting the report on its website within 120 days of the end of its fiscal year, including among other items, the financial statements for the preceding year. This ongoing reporting requirement continues until one of the following occurs:
- The issuing company files at least 1 report and has less than 300 shareholders.
- The issuing company files at least 3 reports and has total assets of less than $10 million.
- All of the issuer’s securities sold under regulation equity crowdfunding are purchased by a third party or repurchased by the issuing company.
- The issuing company becomes a ’34 Act reporting company.
It remains to be seen how regulation equity crowdfunding is received by the business community; however, due to the regulatory burdens, other capital raising methods are probably preferable in most circumstances. With that being said, from a business perspective, greater access to capital is generally a good thing and the new regulations are a welcome step forward. It should be noted, that while not discussed in this article, many states have also enacted their own regulation equity crowdfunding statutes and companies may want to consider those statutes in evaluating their capital raising options.
Kurt practices on Lane & Waterman’s Corporate & Transactional Law team, helping clients with mergers and acquisitions, lending, franchise, tax, real estate, environmental, health care, and securities exchange compliance matters.