Well, that may all change as early as the first quarter of 2014. But it may not change to the degree that some would have preferred.
Yesterday, the five SEC commissioners voted unanimously (that hasn’t happened lately) to propose rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding. The short 585-pages of proposed rules are subject to a 90-day comment period, after which the commissioners will meet again to vote on final rules.
Crowdfunding is supposed to make it easier for startups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors. Some commentators believe, however, that the proposed rules are too restrictive and that, under the proposed rules, crowdfunding will not be the capital-raising success that it otherwise could be.
Given the regulatory hurdles and costs that would be imposed on small businesses by the proposed rules, when weighed against the maximum amount that can be raised, some expect that companies will shun the crowdoffering exemption in favor of pursuing capital solely from accredited investors, which has become less restrictive as a result of the lift on the ban on general solicitation in accredited investor offerings.
Interestingly, although the proposed rules were issued nearly 10 months after the deadline imposed on the SEC by the JOBS Act, the proposed rules closely resemble the foundation for the rules that was outlined in the JOBS Act. Some expected that that lengthy delay meant the SEC was trying to find ways to issue proposed rules that complied with the JOBS Act mandate, but would be more attractive to small businesses. At least the SEC did not impose more restrictive conditions than were handed to it by the JOBS Act.
Below is a brief summary of the proposed rules:
- $1M Maximum Raise. Eligible companies may raise up to $1 million in a 12-month period.
- Cap on Amount of Individual Investments. There will be a cap on the amount that an individual can invest in crowdfunding offerings during a 12-month period. If both the investor’s annual income and net worth are less than $100,000, he or she may invest up to $2,000 or 5% of annual income or net worth, whichever is greater. If either annual income or net worth is equal to or more than $100,000, the investor may invest up to 10% of annual income or net worth, up to a maximum of $100,000.
- Restricted Securities. Securities purchased in a crowdfunding offering could not be resold for one year.
- Investors Don’t Count Toward Shareholder Threshold. Holders of securities sold through crowdfunding would not count toward the threshold that requires a company to register with the SEC and become a reporting company.
- Initial Disclosure by Companies. Companies would be required to file certain information with the SEC and provide it to investors and the relevant intermediary facilitating the crowdfunding offering. The offering documents would have to disclose, among other information, (1) information about officers, directors and 20% stockholders, (2) the use of proceeds from the offering, (3) the target offering amount and the deadline to reach the target offering amount, (4) a description of the financial condition of the company, and (5) financial statements that are accompanied by a copy of the company’s tax returns or that are reviewed (if raising more than $100,000 but less than $500,000) or audited (if raising more than $500,000) by an independent public accountant.
- Annual Report Disclosure. Companies that raise capital through a crowdfunding offering would have to file an annual report with the SEC.
- Not all Companies Eligible. The following companies would not be eligible to use the crowdfunding exemption: (1) non-U.S. companies, (2) SEC reporting companies, (3) certain investment companies, (4) companies that are disqualified under the proposed disqualification rules, (5) companies that have failed to comply with the annual reporting requirements in the proposed rules, and (6) companies that have no specific business plan or have indicated their business plan is to merge or acquire an unidentified company.
To protect investors, crowdfunding offerings are required to take place through an SEC-registered crowdfunding platform that is operated by a registered broker-dealer or a funding portal (a new type of SEC registrant).
- Obligations of Intermediaries. The intermediaries would, among other things, be required to (1) provide investors with educational materials, (2) take measures to reduce the risk of fraud and (3) provide communication channels to permit discussions about offerings on the platform.
- Restrictions on Funding Portals. Funding portals will not be permitted to (1) offer investment advice, (2) solicit purchases, sales or offers to buy securities, (3) hold investor funds or securities or (4) compensate employees based on sales.