The issuer is permitted to communicate with potential crowdfunding investors if the communications occur through the platform but, in spite of the use of the platform or a website link, the final rules limit the ability of the issuer, as well as the ability of others acting on the issuer’s behalf, to advertise. Pursuant to Rule 204, the issuer-company is permitted to advertise the Section 4(a)(6) exempt offering by releasing an offering notice (similar to tombstone ads permitted under Securities Act Rule 134) that contains only the following information:
• a statement that the issuer is conducting an offering;
• the name of the intermediary and a link to the intermediary’s offering page;
• the amount of securities offered (target and maximum);
• the nature of the securities;
• the price of the securities;
• the closing date for the offering;
• the name, address, phone number and website of the issuer;
• the email address of a representative of the issuer; and
• a brief factual description of the issuer’s business.
Will compliance with all of these crowdfunding rules be easier than the traditional Regulation D private placement (without general solicitation)? Certainly the hope was that the crowdfunding rules would allow smaller issuers (and smaller investors) greater opportunities to access capital markets. But the procedural and informational requirements justifiably deemed necessary to protect investors and reduce the risk of fraud make crowdfunding far less accessible than hoped. Only the passage of time will determine which of the recent SEC initiatives prove most popular and affordable to small issuers with limited budgets.
The crowdfunding offering must be conducted through a registered broker-dealer or a funding portal with a “platform”. A “platform” is defined as “a program or application accessible via the Internet or other similar electronic communication medium through which a registered broker or a registered funding portal acts as an intermediary.…” No more than one intermediary can be used for an offering, and the issuer-company is required to make certain disclosures to the SEC, investors and the intermediary facilitating the offering, including:
• A discussion about the size and scope of the offering.
• The specific use or range of possible uses for the offering proceeds, as well as the factors impacting the selection by the issuer of each such use.
• Information about the securities being sold to the public.
• A description of the company’s business operations.
• Information about the company’s officers and directors during the prior three years, including how long they have held those positions and their respective business experience.
• Information about the holders of 20% or more of the company’s outstanding voting securities, as well as a description of the capital structure and any special voting rights or investor rights.
• Identification of Rule 501 and any issuer-company imposed transfer restrictions on the securities offered.
• A discussion of risks associated with an investment in the securities and with participation in a crowdfunded offering.
• A discussion of the financial condition and financial statements of the company, tiered in accordance with the size of the offering such that:
1. Offerings of $100,000 or less require financial statements certified by the company’s principal financial officer.
2. Offerings of more than $100,000 but less than $500,001 require audited financial statements if available or, if a first time crowdfunding exemption user, financial statements reviewed by an outside auditor.
3. Offerings of more than $500,000 up to the $1,000,000 limit require audited financial statements
The offering materials must also include a description of the offering or subscription process and a disclosure of the investor’s right to cancel his/her investment up to 48 hours prior to the deadline identified in the offering materials.
The issuer must complete Form C, which includes details of the initial disclosure about the offering. The completed Form C must be filed with the SEC and either posted by the intermediary on its platform or viewable by investors through a link. The issuer-company must report material changes on Form C-A, periodic updates on Form C-U and ongoing annual filings on From C-AR until the filing obligation is terminated on Form C-TR.
The new rules allow the issuer to engage in limited advertisement of the offering, but there are traps for the unwary. These rules are discussed in the next installment of this blog.
Part 1 of 3 Part Series:
After years of hand-wringing and speculation by entrepreneurs, re-occurring angels, venture capital firms, registered brokers and lawyer types involved with private placements, on October 30, 2015, the U.S. Securities and Exchange Commission (SEC) finally adopted equity crowdfunding rules pursuant to Title III of the Jumpstart Our Business Startup Act of 2012 (JOBS Act). These rules, which rely on Section 4(a)(6) of the Securities Act, are scheduled to be issued in the Federal Register early in 2016 and will become effective 180 days after publication.
Assuming the issuer is not otherwise ineligible, the crowdfunding rules will permit the following:
• A company can raise a maximum aggregate of $1 million through crowdfunding offerings in a 12 month period.
• Individual investors can invest an aggregate sum, over a 12-month period, in any number of crowdfunded offerings, based on the following formulas:
1. If either the individual’s annual income or net worth is less than $100,000, s/he can invest the greater of $2,000 or 5% of the lesser of his/her annual income or net worth.
2. If both his/her annual income and net worth are equal to or more than $100,000, s/he can invest 10% of his/her annual income or net worth, provided that the total investment does not to exceed $100,000.
Not all companies can rely on crowdfunding under the final rules. If the issuer is (i) not organized under the laws of a state or territory of the United States or the District of Columbia; (ii) subject to the Securities Exchange Act of 1934 reporting requirements; (iii) an investment company as defined in the Investment Company Act of 1940, or a company that is excluded from the definition of “investment company” under Section 3(b) or 3(c) of that act; (iv) has a “bad actor” in management or as a major equity holder; (v) has sold securities in reliance on Section 4(a)(6) and failed to make the required ongoing reports within the two-year period before the proposed new offering; or (vi) is a development stage company that has no specific business plan or purpose or does not identify a proposed merger or acquisition target.
The new rules include detailed provisions relating to mandatory disclosures and other requirements, which will be discussed in subsequent posts on this blog.
Nobody wants a “Bad Actor” as part of its working group but, from the perspective of the founder of a startup, the Securities and Exchange Commission’s proposed “bad actor” rules may wind up causing more injury than antidote. The good news is that the SEC is proposing amendments to its rules to implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act to disqualify securities offerings involving certain “felons and other ‘bad actors’” from reliance on the safe harbor from Securities Act registration provided by Rule 506 of Regulation D. See 17 CFR Parts 230 and 239 (Release No.33-9211; File No. S7-21-11. I agree with that effort but, since Rule 506 is one of the three exemptive rules for limited and private offerings under Regulation D, and by far the most popular, it is important that the definitions are carefully tailored. Not all “disqualifying acts” are equal, and “covered persons” and the “bad actor” disqualification should apply only to issuer’s management and controlling equity holders rather than any holder of 10% or more of the entity’s equity. And, even if those changes are not made, the reasonable investigation standard for determining whether “covered persons” are “bad actors” should be no more onerous than the current standard for accepting money from “accredited investors”. Without these changes to the proposed rules, the process of compliance will be beyond the budget and timeline of most startups.