Monday, April 20, 2015

Crowdfunding (the SEC’s Version): What Is It and Where Does It Stand?

Recently, I attended a two-day continuing legal education seminar on the topics of Regulation D Offerings and Private Placements (sounds exciting, doesn’t it?). Crowdfunding, which as you know has been a frequent topic on this blog (see here and here, and even here and here for some examples), was also a significant topic at the seminar. Here are some of the presenters’ key points on the topic:

Crowdfunding is defined as using the Internet and social media to raise capital, usually from a large number of people, and in relatively small amounts from each person. Many start-up businesses that do not have easy access to traditional capital markets and/or venture capital fundraising are eager to engage in crowdfunding.  

In April of 2012, Congress passed the JOBS (Jumpstart Our Business Startups) Act. The JOBS Act  permits crowdfunding, but only subject to rules to be adopted by the SEC. The SEC has not yet adopted any such rules; its Regulation Crowdfunding, known as “Regulation C/F,” was proposed in October 2013, but the SEC is currently continuing to review comments. Unfortunately, until the SEC formally adopts Regulation C/F, crowdfunding as envisioned by the JOBS Act, other than traditional “non-equity” crowdfunding (or possible intra-state crowdfunding), is illegal.

Nevertheless, crowdfunding remains a hot topic in the entrepreneurial services world.  Here are just a few likely specifics about crowdfunding, as currently contemplated by Regulation C/F: 

  • It will be Internet- and social media-based only (in other words, it cannot be conducted by word-of-mouth);
  • Not just anyone will be able to engage in crowdfunding; in fact, public companies, hedge funds, and shell companies are just a few examples of entities that will be prohibited from crowdfunding;
  • There will be a $1 million maximum on funds raised via crowdfunding in any 12-month period;
  • Crowdfunding will have to be conducted through a (i) licensed broker-dealer or (ii) “funding portal” (either is referred to as an “intermediary”). Funding portals will be regulated by the SEC and FINRA and, although they will not be able to offer investment advice or solicit investments, they will have obligations regarding investor education, disclosure, and anti-money laundering; 
  • An investor’s annual investment will be limited. Investors whose income and net worth are below $100,000 will be limited to a maximum investment of (a) $2,000 or (b) 5% of their income or net worth; those whose income or net worth exceeds $100,000 will be able to invest 10% of their income or net worth, but not more than $100,000;
  • Entities engaged in crowdfunding will be required to disclose certain information to the intermediary and investors, including a business plan and financial statements prepared in accordance with GAAP. Additionally, crowdfunders will have to file a minimum of two updates with the SEC, one when the capital raise reaches 50% of its target and another at 100%; and 
  • Shares issued pursuant to crowdfunding will contain transfer restrictions. For a period of one year after issuance, the shares will be transferable only to (i) accredited investors, (ii) the company, (iii) pursuant to an offering registered with the SEC, (iv) family members, or (v) certain trusts.
Unlike “non-equity” funding campaigns managed by Kickstarter or Indiegogo, which provide a gift such as a T-shirt, trinket, or beta access to a product or service in exchange for contributed funds, the SEC’s version of crowdfunding will involve raising capital for a piece of the upside in a business entity, such as shares or membership interests.

The equity crowdfunding dialogue has been going on for several years, and members of our Entrepreneurial Services Group will continue to stay plugged into developments from the SEC (or at the state level) as they occur. 

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