Friday, August 26, 2016

Crowdfunding Offers New Ways for Companies to Access Capital

Effective May 16, 2016, the United States Securities and Exchange Commission (SEC) has adopted rules permitting private companies to offer and sell shares of their stock and other securities via crowdfunding. The SEC’s new rules, named “Regulation Crowdfunding,” permit companies to raise up to one million dollars per year through crowdfunding.

Crowdfunding means raising capital in small amounts from a large number of investors, typically over the internet. The concept has been around for years, with companies using websites like Kickstarter, Indiegogo, or GoFundMe to raise funds for all sorts of projects, such as new technologies, movies, music, or any other sort of project one might imagine. Proponents of crowdfunding cite the “wisdom of crowds” to support the notion that if a large number enough number of people were willing to financially support a project through crowdfunding, it was likely that there would be support for the finished product of the project as well. Investors in such projects historically received some sort of reward for participating in the crowdfunding effort, such as a t-shirt, or a role in the movie being produced, a free copy of the finished product, or at least a discount on its purchase price of the finished product.

Prior to the adoption of Regulation Crowdfunding, however, a company generally could not legally offer stock to crowdfunding investors because to do so would be conducting an unregistered public offering of securities, which was prohibited by state and federal securities laws. Conducting a registered offering of securities is expensive and time consuming, and therefore is not a practical solution for smaller projects seeking crowdfunding support.

Companies considering raising capital through crowdfunding should be aware of the following rules under Regulation Crowdfunding:
  • Annual company limit. A company may raise up to $1,000,000 via crowdfunding in any 12-month period.
  • Annual investor limit. The aggregate amount of crowdfunding investments that any one investor may make in any 12-month period across in all companies conducting crowdfunding offerings is limited as follows:
    • If the investor has either an annual income or a net worth of less than $100,00, then the investor’s annual investment limit is equal to the greater of (i) $2,000, or (ii) 5% of the lesser of the investor’s annual income or the investor’s net worth; and
    • If the investor has both an annual income and a net worth of $100,000 or more, then the investor’s annual investment limit is equal to 10% of the lesser of the investor’s annual income or the investor’s net worth.
  • Crowdfunding platform required. A company must conduct crowdfunding offerings only through a single intermediary that maintains a crowdfunding platform registered with the SEC.
  • Offering disclosure requirements. A company conducting a crowdfunding offering must file a new form adopted by the SEC called a Form C.  The Form C is required to provide potential investors and the SEC with information about the company, the company’s officers, directors and promotors, the company’s financial performance, the securities offered, and the offering itself. The disclosure must include the minimum and maximum dollar amount of securities offered via crowdfunding and risks involved in making the investment.
  • Ongoing reporting requirements. After completing a crowdfunding offering, a company is required to file an annual report with the SEC which includes financial statements. If the company has had its financial statements reviewed or audited by a CPA, it must file those reviewed or audited financial statements.  
  • Advertising limited. A company is not permitted to advertise its crowdfunding offering, but the company is permitted to advertise a simple notice of the offering directing investors to the company’s crowdfunding platform. The notice must be limited to factual information about the company and the crowdfunding offering and may include a brief description of the company’s business.
  • Promotor compensation. A company is permitted to compensate promotors of the crowdfunding offering, but any such compensation must be disclosed to potential investors in connection with the promotion of the offering.
  • Resale restrictions. Securities purchased in a crowdfunding offering generally may not be re-sold or otherwise transferred by investors during the first 12 months after their investment.
  • Bad actor disqualifications. A company is generally not permitted to conduct crowdfunding offerings if the company or any of its officers, directors, substantial shareholders, promotors or affiliates have been involved in any disqualifying events, such as regulatory bans from participation in the banking or securities industries or felony convictions related to past securities industry activities.
  • Crowdfunding platform mechanics. A company must file its Form C with the SEC and make it available to potential investors through their crowdfunding platform at least 21 days before selling any securities and at all times during the offering. The crowdfunding platform must provide a communication channel which permits potential investors to communicate with each other and with the company. The crowdfunding platform must be operated by a registered broker-dealer or it must maintain an escrow account for investor funds with a broker-dealer, bank or credit union. The company must identify a deadline for cancelling an investment in its offering materials and grant investors the right to cancel their investment. The cancellation right generally expires 48 hours prior to the deadline unless there is a material change to the offering.  If the company does meet receive the minimum amount of investments by the deadline or the offering otherwise is not completed, the platform must return any investor funds received.   
The SEC hopes that Regulation Crowdfunding will open up new opportunities for small business to access capital. Time will tell if companies and investors determine the new regulations meet their capital and investment needs.

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