President Obama signed the “Startup Our Startup Act” (the JOBS Act) on April 5. Part of this law authorizes crowdfunding for the first time. (Until now, crowdfunding could only be legally performed by a company that effectively provides its goods or services at a discount.)
However, that does not mean that crowdfunding provisions take effect immediately. The law gives the Securities and Exchange Commission 270 days to issue regulations for crowdfunding offerings. You can’t crowdfund before the SEC issues those regulations. Still, the Act is expected to open crowdfunding for several smaller companies.
The crowdfunding exemption applies to issuers that do not sell more than $ 1 million to investors under any exemption during a 12-month period. Companies that want to raise more than $ 1 million in 12 months will not be able to use crowdfunding.
In short, the amounts investors can invest are limited by their income and net worth. Crowdfunding must be done through “Conduits” registered with the Securities & Exchange Commission (SEC). Issuers may not advertise except in notices directing investors to the Conduit. Issuers must also file annual reports with the SEC. In terms of financial disclosures, offers of less than $ 100,000 in a year are only required to provide financial and income tax returns certified by their CEO. With offers between $ 100,000 and $ 500,000 in a year, finances must be reviewed by a certified public accountant. For offers between $ 500,000 and $ 1 million, finances must be audited.
Investor amount restrictions
There are some restrictions on how much investors can invest. Investors with annual income of less than $ 100,000 or whose net worth (presumably excluding primary residence) is less than $ 100,000 can only invest in any 12-month period, the greater of $ 2,000 or 5 percent of income annual investor or net worth. One thing that companies that use crowdfunding should consider is if they want to set higher minimums for investment, since the administrative time for a small investor is usually as long as for a large investor. If $ 1,000,000 were raised by having 500 people invest $ 2,000 each, the administrative time per investor could be a substantial portion of the $ 2,000 contributed by each investor.
If the investor’s annual income or net worth (again, presumably excluding primary residence) is equal to or greater than $ 100,000, then the investor may invest 10 percent of the investor’s annual income or net worth in any 12 period. months. , without exceeding a maximum amount of $ 100,000.
(There is an inconsistency in the wording of the statute in these two categories. Presumably, to fit into the second category, the investor must have income greater than $ 100,000 AND (not “or”) a net worth of more than $ 100,000. Wait the SEC to address this in its regulations).
Registered conduit required
For better or for worse, the transaction must be made through a licensed securities broker or funding portal (either of which we’ll call a “Conduit”) that has registered with the SEC for crowdfunding. The Conduit must also register with any applicable self-regulatory organization, such as FINRA. (There are people who are not stockbrokers who must register with FINRA). Part of Conduit’s duties are: to provide information to investors related to risks; ensure that each investor reviews the investor education information; and confirm that the investor understands that the investor is risking the loss of the entire investment, that the investor could bear such a loss, that the investor understands the level of risk applicable to investments in startups, emerging businesses, and small issuers, and understands the risk of illiquidity.
The Conduit must also obtain a background check and regulatory securities compliance background from each officer, director, and person who owns more than 20 percent of the outstanding capital of each issuer whose securities are offered. In addition, the Conduit must ensure that all proceeds from the offering are only provided to the issuer when the total capital raised from all investors is equal to or greater than the target offering amount, and allow all investors to cancel their investment commitments. (There are other requirements as well).
Actions required of issuers
Issuers using crowdfunding also have requirements to meet. The issuer must file an application with the SEC.
In addition, an issuer using the crowdfunding exemption cannot announce the terms of the offer, except in the case of notices directing investors to the financing portal or broker, and not less than once a year to file with the SEC and provide investors with reports of the issuer’s financial statements results of operations. This is unusual in that most private placement offerings do not require annual SEC filings.
Regarding non-financial disclosures to investors, the issuer must provide, among other things: a) the names of the directors and officers (and any person who occupies a similar status or who performs a similar function), and each person who owns more than 20 percent of the issuer’s shares; and b) the issuer’s anticipated business plan. There is not much surprise there.
The issuer must also disclose, among other things, 1) the target offer amount, the deadline for reaching the target offer amount, and regular updates on the issuer’s progress in meeting the target offer amount; and 2) a description of the issuer’s ownership and capital structure. The latter should include, in addition to other matters, (a) the terms of the issuer’s securities being offered and each other class of issuer security; (b) a description of how the exercise of the rights of the principal shareholders of the issuer could adversely affect buyers of the securities offered; and (c) how the securities offered are valued, and examples of methods of how the issuer may value those securities in the future.
Financial description requirements depend on the amount raised. For offers that, together with all other crowdfunding offers from the issuer within the preceding 12-month period, total $ 100,000 or less, the issuer must provide: (i) income tax returns filed by the issuer for the most recently completed year, if any, and (ii) the issuer’s financial statements, which must be certified by the issuer’s chief executive officer to be true and complete in all material respects (but do not need to be audited).
When the current offering plus other crowdfunding offers by the issuer total more than $ 100,000 but less than $ 500,000, the issuer must provide financial statements reviewed (but not audited) by a certified public accountant who is independent of the issuer.
When the total of the current offering and crowdfunding offers in the last 12 months total more than $ 500,000, audited financial statements are required. Given the expense of audited financial statements and the $ 1,000,000 limit on offerings, some issuers may decide not to take the crowdfunding approach.
Priority of state law
Fortunately, crowdfunding provisions appear to pre-empt state law with respect to state registration, documentation, and bidding requirements. The provisions still allow states to take steps to enforce the law. States can require filing of notices (as they do with Rule 506 offers) but not charge filing fees. (Section 305.)
Much will depend on the regulations issued by the SEC.