Late last week, the SEC adopted its final rules for equity crowdfunding under Title III of the JOBS Act. These rules, when implemented, have the promise of reducing the cost and increasing the availability of sorely needed capital for the early-stage and emerging growth companies that fuel our economy with new products and services, job creation, and wealth. In addition, we may finally see the real democratization of access to these high-risk, high-reward investment opportunities as such investments become available to not only our wealthiest and best-connected investors but also to ordinary investors who previously have been largely cut out of these opportunities because they fail to meet accredited investor requirements.
As counsel to hundreds of early-stage and emerging growth companies, to innovators and entrepreneurs, and to the investors who support them, we have been following crowdfunding developments closely. After nearly four years of waiting and pondering and some disappointments and missteps, the SEC has finally adopted rules that are intended to decrease the cost of legal compliance and broaden investment opportunities and access, with the likely result of increasing the amount of capital available to early-stage companies even as important investor protections are maintained. These investor protections, as discussed more fully below, will be particularly important after the new rules are effective, as less-sophisticated investors will be joining in these exciting, but high-risk, investment opportunities.
The SEC imposed limitations and obligations, both on the companies seeking to raise capital and the potential new investors, including issuer disclosure and financial statement obligations and investor limitations on the amounts investable through crowdfunding. Under these protective rules, crowdfunding must be conducted online through a broker or a funding portal with financial information and details relating to the plan of distribution. These limitations are intended not only to protect “widows and orphans” but also to maintain the very integrity and reliability of the market to raise and access capital. The initial equity crowdfunding proposal by the SEC in 2013 called for audited financial statements for any company seeking to raise more than $500,000 through crowdfunding. The new rules, however, did away with this expensive requirement, which likely would have had a chilling effect on capital raising. In order to protect investors and provide adequate information with which to make informed investment decisions, the SEC rules require that reviewed financial statements be provided. The new rules allow companies to raise up to $1 million in any 12-month period from accredited and nonaccredited investors alike. Unlike Reg A+ offerings, shares issued in a crowdfunding transaction must be held by the investor for at least one year before they may be resold. Liquidity and tradability, therefore, remain significant issues.
The SEC appropriately incorporated certain measures to protect investors from their own exuberant (or overly enthusiastic) reaction to early-stage company investment opportunities. People whose income or net worth is less than $100,000 may invest, in the aggregate across all crowdfunding offerings, up to the greater of $2,000 or 5 percent of the lesser of their annual income or net worth; individuals with income or net worth equal to or greater than $100,000 may invest as much as 10 percent of the lesser of their annual income or net worth, up to a ceiling of $100,000, such that no individual (whether accredited or not) will be able to purchase in a single year more than $100,000 of securities through any crowdfunding investments. These restrictions are intended to limit the exposure of individuals to the presumptively riskier investments employing crowdfunding techniques.
While most people previously were barred from participating in the exciting opportunities to invest in early-stage and emerging growth companies, the new equity crowdfunding rules will provide access to all people who want to participate in this important market and investment segment. This is a big step toward democratizing access while enhancing the fundraising activities of early-stage companies. As with all investment activities, there are risks and rewards, challenges and opportunities. The new Title III crowdfunding rules recognize the importance of enhancing capital-raising activities and results while also embracing an historic imperative to provide a sufficient and appropriate level of investor protection.