On October 30, 2015, the Securities and Exchange Commission (the “SEC”) adopted, by 3-1 vote, the final rule permitting companies to offer and sell securities through crowdfunding under Title III of the JOBS Act.
Crowdfunding, the practice of funding a venture with many small investments from a large number of people, typically via the Internet, has become an increasingly popular method of fundraising, but generally has not been used to offer and sell securities for fear of triggering the burdensome registration and reporting requirements of federal securities laws. The JOBS Act created a crowdfunding exemption under federal securities laws, and the final rules established by the SEC seek to effectuate that exemption. The rules attempt to provide smaller companies with innovative ways to raise capital, while still protecting individual investors, via a regulatory framework that applies to three primary groups.
First, the rules permit eligible companies to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period, while imposing disclosure and annual reporting requirements that increase according to the amount of funds raised. Companies that are not eligible to engage in crowdfunding under the rules include non-U.S. companies, Exchange Act reporting companies, and certain investment companies, among others.
Second, the rules permit individual investors to invest, over a 12-month period, an aggregate amount ranging from $2,000 to $100,000, depending on the investor’s income or net worth. Securities purchased under these rules, though, generally cannot be resold for a period of one year.
Third, all transactions relying on the final rules must take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Funding portals face less extensive registration requirements than broker-dealers but are subject to various additional restrictions such as not being able to solicit securities displayed on their platform. The final rules require intermediaries to, among other things: take various measures to reduce the risk of fraud on the part of the offering company, make information that an offering company is required to disclose available to the public on its platform before and during the offering period, and comply with various maintenance and transmission of funds requirements.
Ultimately, these crowdfunding rules provide issuers an additional and trendy way to access capital, but the annual $1 million crowdfunding cap may not be worth the cost of compliance. Indeed, a private placement to only accredited investors under Rule 506 of the Securities Act may involve much lower compliance costs without subjecting the issuer to any investment cap. As such, issuers should consider the broad range of fundraising alternatives available to them before they pile on to the crowdfunding bandwagon.
The new crowdfunding rules and forms will be effective 180 days after they are published in the Federal Register. The forms enabling funding portals to register with the Commission became effective January 29, 2016.