The Securities and Exchange Commission voted 3-1 to issue final crowdfunding rules under the JOBS Act at an open meeting held on October 30, 2015.  The final rules permit startups and small businesses to raise capital outside the established securities markets using SEC-registered funding portals.  The final rules are collectively known as “Regulation Crowdfunding.”  The final rules and forms will be effective 180 days after they are published in the Federal Register, except that the forms enabling funding portals to register with the SEC are effective January 29, 2016.

Key Changes from the Proposed Rules

The final rules were modified significantly from the prior October 2013 rule proposal, including to:

  • exempt 1st time issuers from being required to file audited financial statements;
  • eliminate the requirement to file audited or reviewed financials annually;
  • provide for termination of ongoing reporting requirements under certain circumstances;
  • provide for streamlined Q&A style disclosure;
  • reduce the amount certain investors can invest;
  • allow platforms to receive equity compensation; and
  • allow funding portals to curate investment opportunities

Who Can Invest and How Much Can Be Raised and Invested

The new rules permit all individuals, including non-accredited investors, to purchase securities in crowdfunding offerings. 

  • Companies may raise up to $1 million in a 12-month period.
  • Individuals may invest in crowdfunding offerings over a 12-month period in compliance with the following limits:
    • If annual income or net worth is less than $100,000, an individual may invest the greater of $2,000 or 5% of the lesser of annual income or net worth; or
    • If both annual income and net worth are equal to or more than $100,000, an 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 investor through all crowdfunding offerings may not exceed $100,000.

Non-U.S. companies, companies that are already filing reports with the SEC under the Securities Exchange Act of 1934 (the Exchange Act), so called blank check companies, and certain investment companies may not use Regulation Crowdfunding.  In addition, companies disqualified under Regulation Crowdfunding or that fail to comply with the annual reporting requirements may not rely upon the rule to offer securities.

Securities purchased in a crowdfunding transaction can generally be resold after being held for one year.  In addition, a crowdfunding company will not trigger large-scale SEC reporting requirements under Exchange Act Section 12(g) on account of exceeding the shareholder number threshold if the company remains current with its annual Regulation Crowdfunding reporting obligations, retains the services of a registered transfer agent, and has less than $25 million in total assets as of the end of its fiscal year.

Disclosure Requirements – Offerings and Ongoing Reporting Obligations

Companies must provide certain information to investors, file it with the SEC, and post the information in the crowdfunding portal.  The information includes the price of the securities, financial condition of the company, use of proceeds from the offering, background of management, identity of large shareholders, and related party transactions.

Crowdfunding companies must also provide financial statements.  For offerings under $100,000, companies must provide only tax returns and financial statements certified by their CEO (unless audited financial statements are available).  For mid-size offerings between $100,000 and $500,000, companies must provide financial statements that are reviewed, rather than audited, by an independent public accountant.  For larger offerings over $500,000, the financial statements must be audited by an independent auditor.  However, for first time offerings between $500,000 and $1 million, the SEC elected to permit reviewed rather than audited financial statements (unless audited financial statements are available). 

Companies relying on the crowdfunding exemption are required to file an annual report with the SEC and provide it to investors.  The information required in the annual report is the same information required in the offering statement delivered to investors and includes, among other things, names of directors, officers and large shareholders, business description, financial condition, risk factors, use of proceeds, capital structure, prior securities offerings, and related party transactions.

Crowdfunding Platforms

Companies using Regulation Crowdfunding must conduct their offering through an intermediary that is either a broker-dealer or a funding portal registered with the SEC.  Like broker-dealers, a funding portal must become a member of FINRA.  Intermediaries must, among other things, provide investors with materials that explain the investment and investment process, conduct certain due diligence with respect to the company and the offering, maintain investor/shareholder records, maintain offering materials on the intermediary platform, maintain a channel for investor communication, and disclose all compensation received for services.

The final Regulation Crowdfunding allows intermediaries to receive equity in the companies on its platform as compensation for its services, but prohibits directors, officers or employees of an intermediary from receiving equity or any other financial interest from a company that is offering or selling securities on its platform.

While funding portals must register with the SEC like broker-dealers, the rules applicable to funding portal intermediaries under Regulation Crowdfunding are more limited than the SEC’s rules regarding registered broker-dealers.  As is required for broker-dealers, however, funding portals are required to maintain certain books and records related to their transactions and business.  Funding portals may file with the SEC and FINRA beginning on January 29, 2016, with the application and approval process expected to take two to four months.