On October 30, 2015, in a 686-page document, the Securities and Exchange Commission (SEC) adopted final rules permitting companies to offer and sell securities through crowdfunding portals. Title III of the JOBS Act first created the exemption under the federal securities laws so internet crowdfunding could be used to raise capital, which was finalized by the October 30, 2015 publication. The rules take effect 180 days after publication in the Federal Register, so the first crowdfunding offerings are expected to begin in mid-2016.
A Review of the Crowdfunding Rules
According to the SEC Press Release, the final rules are intended to "give small business an additional avenue to raise capital and provide investors with important protections." While the previous securities laws required investment to come from high-income, accredited individuals and institutions, the new rules open the investor base to all individuals. Specifically, the new rules provide for the following:
- Allow a company to raise a maximum aggregate amount of $1 million through crowdfunding in a 12-month period;
- Allow individual investors to invest in crowdfunding offerings, limited to the following aggregate amounts over a 12-month period:
- If the annual income or net worth of the individual is less than $100,000, the individual may invest the greater of:
- $2,000, or
- 5% of the lesser of the individual's annual income or net worth
- If the annual income and net worth of the individual is $100,000 or more, the individual may invest 10% of the lesser of annual income or net worth
- During the 12-month period, the aggregate amount of securities sold to an individual investor through crowdfunding may not exceed $100,000
- Require that securities purchased in a crowdfunding issuance may not be resold for one year
- Require that all crowdfunding transactions take place through an SEC-registered funding portal (i.e. a registered crowdfunding website), which are subject to various investor protection and education requirements
Investor protection continues to be the major concern of the SEC in its rulemaking. The SEC requires companies making a crowdfunding offering to disclose the following information to the SEC and investors:
- The price to the public or the method for determining the price
- The target offering amount
- The deadline to reach the targeted offering amount
- 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, which depending on the offering amount, may need to be reviewed or audited by an independent public accountant
- A description of the business and intended use of the proceeds of the offering
- Information about officers, directors, and owners of 20% or more of the company
- Certain related-party transactions
Companies will also be required to file an annual report with the SEC and provide the report to its investors.
Certain companies are ineligible from crowdfunding, including a company that fails to comply with the annual reporting requirements for two years, or a company that has no specific business plan or that has a business plan to engage in a merger or acquisition with another company.
What it Means
The new rules greatly improve the access to capital of small businesses, while aiming to protect investors from irresponsible or dishonest companies and fund-seekers. The new rules could prove revolutionary for startups, but companies should keep in mind the rules remain in their infancy, and will likely come with certain growing pains. Startups considering crowdfunding should pay close attention as the successes and pitfalls of the new crowdfunding rules begin to take shape.