The Securities and Exchange Commission (the SEC) has recently adopted final rules allowing private companies to sell securities to investors through internet-based crowdfunding. Pursuant to Regulation Crowdfunding, which becomes effective May 16, 2016, offers and sales of private securities will be available to both accredited and unaccredited investors, but subject to a number of significant requirements and limitations, many of which are described below.
Of what offering limitations must companies be aware?
Regulation Crowdfunding limits the amount of capital that an eligible company can raise through crowdfunding to a maximum of $1 million in any 12-month period. However, companies may simultaneously raise capital using other Securities Act exemptions (such as Regulation D) without the need to aggregate the amounts raised for purposes of the limitation.
Of what limitations do individual investors need to be aware?
Individual investors are permitted to invest in the aggregate, across all crowdfunding offerings, up to ten percent of the lesser of annual income or net worth if both annual income and net worth are equal to or greater than $100,000 (lower limits for those with incomes or net worth below $100,000). Investors also need to be aware that their ability to resell securities purchased through crowdfunding will be extremely limited. Securities purchased through crowdfunding generally will not be permitted to be resold for one year, and a secondary market for the securities is unlikely to develop. Investors must understand that as a practical matter, these interests are highly speculative and illiquid.
What is a funding portal, and do companies have to use one?
Transactions relying on the new rules will be required to take place through an SEC-registered intermediary – either a broker-dealer or a funding portal. Companies may only offer securities through one intermediary at a time. Funding portals are a new type of entity that will be required to register with the SEC using the new “Form Funding Portal” and must become members of the Financial Industry Regulatory Authority. Funding portals will face a wide range of restrictions, including a prohibition on the recommendation of securities, as well as on the solicitation of purchases or sales of securities. The compensation of funding portals by companies may be fee-based, or it may be comprised of the company’s securities, so long as they are the same securities as those offered on the portal.
What disclosure is involved?
Companies contemplating this type of offering should carefully consider the disclosure and annual reporting requirements (and accompanying costs), which come along with crowdfunding. Detailed information about the offering and the financial condition of the company must be provided to the SEC, to investors, and to the intermediary facilitating the offering. Critically, the new Regulation offers no exemption from antifraud rules and requires that disclosures not mislead investors.
The procedural and substantive requirements of the new Regulation are much less onerous than those associated with a public offering, but they are not conducive to a do-it-yourself approach. As the new rules are untested, an inadvertent failure to comply may allow unhappy investors to obtain a refund. Questionable compliance with such requirements may also impair an issuer’s ability to find a willing acquirer.
For which types of securities is the Regulation most appropriate?
For the most part, issuers should be cautious about using this Regulation to offer anything other than simple equity (i.e., not involving preferred rights, options or warrants, multiple series, etc.), and should understand that after one year, purchasers are legally free to resell the securities in private transactions – possibly to competitors or other ‘undesirables’. Offerings of more complex securities to VC’s and other sophisticated investors may still be accomplished in traditional private placements alongside crowdfunded simple equity deals. Further, foreign companies and pooled investment vehicles are not eligible to offer securities pursuant to this Regulation.