CrowdFail: How New SEC Rules Hinder Crowdfunding Via Stream Industry

SEC Rules On Crowdfunding
SEC Rules On Crowdfunding

Following the popularity of gift-based fundraising sites  Kickstarter and Indiegogo and micro-loan portals  Kiva and  Zidisha , there was much excitement when Congress created a new exemption to federal securities laws allowing companies to issue securities via crowdfunding – i.e., collecting small amounts from a large number of investors in exchange for ownership stakes in the business itself – as part of its Jumpstart Our Business Startups Act (the “JOBS Act”). The bill was signed into law by President Obama on April 5, 2012. On October 23, 2013, a year and a half later, the SEC released a 585 page document containing its much anticipated Proposed Rules for Crowdfunding (note: here’s the press release and a short version). After 90 days of public comment, companies can finally start issuing stock and other securities through online crowdfunding “portals” and brokerages. Alas, given the cost of compliance with these burdensome regulations, it is doubtful there will be much interest in this type of crowdfunding.

Generally, an offer or sale of securities must be registered with the SEC unless an exemption is available. Title III of the JOBS Act creates a registration exemption under the 1933 Securities Act, so that crowdfunding can be used to offer and sell securities, and establishes a regulatory structure for this funding method. To qualify for the exemption, companies must meet the following limitations and disclosure requirements.

Investment Limits

  • A company can raise a max aggregate amount of $1 million through crowdfunding in a 12 month period;
  • Limits on how much an individual investor may invest via crowdfunding (note: Annual income and net worth can be calculated jointly with a spouse):

Investor status

Investment limit (per 12 month period)

Both annual income and net worth less than $100K $2, 000 or 5% of annual income or net worth, whichever is greater
Either annual income or net worth greater than $100K 10% of annual income or net worth, whichever is greater, to a maximum of $100K
  •  Securities purchased under the crowdfunding exemption cannot be resold 1 year
    • Some exemptions include transfers back to the issuer, to accredited investors, as part of an offering registered with the SEC, to a family member in connection with certain events (death or divorce), or to a trust controlled by the investor or created for the benefit of an investor’s family member
  • Certain companies are not eligible to use the crowdfunding exemption, including: Non-US companies, Companies that already are SEC reporting companies, Certain investment companies, Companies that are disqualified under the proposed disqualification rules, Companies that have failed to comply with the annual reporting requirements in the proposed rules, and Companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies
  • Companies are not allowed to advertise terms of the offering except for notices which direct investors to the funding portal or broker
  • Companies are able to raise money simultaneously through private placements without those funds counting towards the $1 million crowdfunding cap.

Disclosure Requirements

  • Companies must file certain disclosures with the SEC, provide it to investors and the relevant intermediary, and make it available to potential investors. The Information that MUST be disclosed includes
    • Information about officers and directors and owners of 20% or more of company
    • Description of business and use of proceeds
    • Price to the public of the securities being offered, the target offering amount, deadline to reach target offering amount, and whether the company will accept investments in excess of target offering amount
    • Certain related-party transactions
    • Description of company’s financial conditions
    • Financial statements that would have to be accompanied by a copy of tax returns or reviewed or audited by an independent public accountant or auditor
  • Companies raising more than $500k a year must provide audited financial statements
  • Description of investors’ rights
  • Companies must amend offering document to reflect material changes and provide updates on progress toward reaching target offering amount
  • Companies must file an annual report with the SEC and provide it to investors. This requirement continues until 1) the issuer becomes a reporting company; 2) the issuer no longer has any shareholders who purchased securities through the crowdfunding exemption; or 3) the issuer liquidates or dissolves.
    • An issuer would be barred from conducting a crowdfunding offering if it has failed to file annual reports for a previous crowdfunded offering during the two years immediately preceding the filing of a new offering statement.

Intermediary Requirements

  • Crowdfunding transactions must take place through an online SEC-registered intermediary, either a broker-dealer or a “funding portal” (the latter being a new type of SEC registrant)
  • An issuer would be restricted to using only one intermediary for its offerings at any one time

Costs Outweigh the Benefits

On the positive side, the new rules give companies a chance to raise additional funds in supplement to all other types of finance and access to many small investors through online “portals” they would not be able to reach through traditional private placements. Deloitte even expects all forms of crowdfunding to hit $3 billion globally this year and to grow at a compound annual growth rate … [ Continue Reading The Complete Article On Stream Industry ]

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Stream Industry is a trade site that publishes empowering analysis on the converging communications, media, and entertainment industries. While we are not a law firm and do not purport to give you any financial or legal advice, our members include select lawyers, business professionals, and industry experts who author enlightening articles that pierce straight to the heart of complex issues and make them easy to understand.

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(Image Credit – SEC.gov )

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