‘Regulation’ Crowdfunding is Finally HereDecember 15, 2015 – Articles The Legal Intelligencer
Some call it equity crowdfunding. Some call it Title III crowdfunding. Now apparently the SEC calls it regulation crowdfunding. Regardless of what it is called, it is finally legal. On Oct. 30, 2015, the SEC issued final rules and forms implementing Title III of the JOBS Act. This comes more than three years after the enactment of the JOBS Act, and more than two years after the SEC was required by Congress to implement final rules legalizing Title III crowdfunding.
Title III of the JOBS Act was intended to be the marriage between the social networking world that we have become, and the traditional and regulated capital-raising world that has existed for many, many years by making it possible for companies seeking capital to reach nonaccredited investors through offerings of equity on the Internet. Plagued by years of disagreement focusing on the implementation of the difficult statutory scheme that Congress handed to the SEC in Title III, as well as concerns about the heightened opportunity for fraud and abuse that Title III potentially brings, the rule-making process was stalled in the SEC for a long time. Not any longer.
In the world of raising capital in compliance with federal and state securities laws, there is a popular saying among those in the know—every offering is either registered, exempt from registration, or illegal. Prior to Title III, an offering over the Internet to the "masses" would have been illegal. Now, Title III creates a new exemption from registration under the Securities Act of 1933 for a new form of crowdfunding. This new form of crowdfunding must be conducted through "crowdfunding intermediaries"—Internet portals that meet certain conditions in order to handle these crowdfunding offerings. Any company utilizing Title III must follow a strict set of implementing rules in order to avail itself of this new exemption from registration.
Title III offerings must not exceed maximum amounts of capital raised per issuer and amounts invested per individual investor. Specifically, an issuer cannot raise more than $1 million in any rolling 12-month period. In determining whether an issuer has reached this maximum amount, any amounts raised by the issuer in other concurrent Title III offerings will be aggregated. What does not count is any amounts raised by the issuer under any other exemption from registration. In terms of the per-investor limits imposed by Title III, these depend on the net worth or annual income of each individual investor. For individuals with either an annual income or net worth that is less than $100,000, that investor cannot invest more than the greater of $2,000 and 5 percent of the lesser of the investor's annual income or net worth. All other individuals are limited to investing up to 10 percent of the lesser of the investor's annual income or net worth, but not to exceed $100,000 for each investor.
Companies intending to utilize Title III crowdfunding are now subject to significant information reporting requirements. Under the final rules issued by the SEC, a Title III crowdfunding issuer is required to file a new form C on EDGAR (the SEC's electronic filing system) before the offering is commenced. Among many other things, form C will include information on:
• the issuer (name, address, type of entity and website address).
• the issuer's officers and directors.
• the issuer's 20 percent or greater shareholders or equity holders.
• the issuer's business and business plan.
• the use of proceeds.
• the target offering amount and deadline to reach it.
• the offering price and how it will be determined.
• the risks of investing in the business.
This is far from an exhaustive list of information that must be disclosed in the new form C, and is being provided to highlight the significant disclosure requirements with which issuers in these offering must comply.
In addition, an issuer in a Title III offering must provide specific financial information to its potential investors. The extent of the financial information and the level of detail or verification needed depend on the amount of capital being raised by the issuer. In offerings of $100,000 or less, issuers must provide Generally Accepted Accounting Principles or US GAAP financial statements for the two most recently completed fiscal years (or shorter period for companies not then two years old), and total income, taxable income and total tax reflected on the issuer's federal tax return for the most recently completed fiscal year. For offerings between $100,000 and $500,000, an issuer must provide US GAAP financial statements for these same periods, but these must be reviewed by an independent public accountant. For offerings greater than $500,000, a reviewed financial statement suffice for the first offering, but audited financials are required for any subsequent offerings. These reporting requirements continue annually until the issuer becomes a public company, has less than 300 equity holders, has filed three annual reports and has total assets of less than $10 million, the securities sold in the offering are sold to a third party or repurchased by the issuer, or the issuer goes out of business.
The attractive aspect of a Title III crowdfunding is the ability to advertise the offering to the public. Prior to the enactment of the JOBS Act, advertising a private securities offering to the public was not permitted. This was the so-called "general advertising and general solicitation" restrictions imposed by Regulation D of the Securities Act of 1933. Now, issuers in a Title III crowdfunding can advertise publicly that they are selling securities, although their advertisement must be limited to directing their investor audience to the internet portal that is conducting their offering. The issuer is then free to communicate with its investors or potential investors through the portal, opening a whole new landscape in investor solicitations and communications.
Three other aspects of the new rules issued by the SEC are noteworthy. First, Title III offerings will not be integrated with any other exempt offering being conducted by the issuer, as long as the issuer strictly complies with each of the respective exemptions. In addition, securities purchased in a Title III crowdfunding offering are restricted securities and cannot be resold for a one-year period, subject to a few limited exceptions. Finally, an issuer in a Title III crowdfunding does not need to count the investors in that funding when determining if it has crossed the shareholder threshold that would cause it to be a public reporting company.
Regardless of whether it is called regulation, equity or Title III crowdfunding, it is now legal. What remains to be seen is how significant of an effect it will have on capital-raising activities. Congress intends it to be a new frontier in raising capital for companies. Due to the significant requirements imposed on an issuer in such an offering, and coupled with the fact that an issuer will have potentially hundreds (or more) of investors who will be complete strangers to the company, it is unlikely to achieve the new frontier status intended by Congress. Only time will tell, though.
Reprinted with permission from the December 15, 2015, edition of the New Jersey Law Journal © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877.257.3382 -[email protected] or visit www.almreprints.com.