New Crowdfunding Rules: Good for Small Companies But at What Cost?
This is the second part of our three-part article discussing the SEC’s new equity crowdfunding rules and how they will impact companies (the issuers) and investors.
This article discusses the numerous requirements that companies must fulfill to be compliant with the equity crowdfunding rules under Title III of the JOBS Act.
Issuer Disclosure Requirements
Companies that wish to take advantage of the equity crowdfunding rules must file Form C on the SEC’s EDGAR system before commencement of the offering. Among other things, Form C must include the following items about the issuer:
- The name, legal status, address and website of the issuer.
- The names of the issuer’s directors and officers (or anyone with a similar status or performing a similar function), each person holding more than 20% of the shares of or interest in the issuer, and the number of current employees.
- A description of the issuer’s business and the anticipated business plan.
- A description of the purpose and intended use of the proceeds of the offering.
- The target offering amount, the deadline to reach the target amount, and whether the issuer will accept investments in excess of the target amount.
- The offering price of the securities being offered and how the price was determined.
- A description of the issuer’s ownership and capital structure, including information about the terms of the securities being offered and other outstanding securities of the issuer.
- The identity of the intermediary for the offering, compensation being paid to the intermediary to conduct the offering, and any other fees associated with the offering.
- Risk factors of the offering, including the risks of being a minority owner.
- The issuer’s financial condition.
- A description of the material terms of the issuer’s indebtedness, other exempt offerings of the issuer during the last three years, and related-party transactions.
In addition to the items on Form C, the issuing company must also file reports disclosing any material changes with the company, additions or updates to the information provided to investors for an offering that has not yet been completed or terminated.
An issuer must also provide updates about its progress toward meeting the target offering amount no later than five (5) business days after the date that it reaches 50% and 100% of the target offering amount. This information may be publicly posted by the intermediary on its platform or filed by the issuer on the SEC’s EDGAR system.
Length of Offering and Cancellation of Investment
The offering must be open for at least twenty-one (21) days. During this time, investment commitments from potential investors may be accepted. However, companies must provide information on how investors can cancel an investment commitment. Potential investors are allowed to cancel their commitment for any reason up to 48 hours prior to the deadline specified by the company.
Within the 48-hour window, commitments may only be canceled if there is a material change in the offering or the company’s business. If a material change to the offering occurs, investors must reconfirm their commitment or it will be cancelled and the funds returned. Also, the investment commitments will be cancelled and the funds returned if the target amount is not met.
Financial Disclosure Requirements
The equity crowdfunding rules require the company to provide the following financial information, depending on the aggregate amount the company is seeking to raise or has raised in a rolling 12-month period.
|Amount Sought or Raised||Type of Financial Disclosures|
|$100,000 or less||Financial statements and specific items from income tax returns, both certified by the principal executive officer of the company.
|$100,000.01 to $500,000||Financial statements reviewed by an independent public accountant and the accountant’s review report.
|$500,000.01 to $1 Million||If this is the company’s first offering under the equity crowdfunding rules, then financial statements reviewed by an independent public accountant and the accountant’s review report.
Otherwise, audited financial statements provided by an independent public accountant and the accountant’s audit report.
Annual Reporting Requirements
Crowdfunding issuers will be subject to ongoing reporting requirements. Issuers will need to file an annual report with the SEC, no later than 120 days after the end of the most recently completed fiscal year covered by the report. The annual report must contain information similar to that required in the offering statement, including disclosure about the issuer’s financial condition, and must also be posted to the issuer’s website.
The financial statements of the issuer included in the annual report must be certified by the principal executive officer as true and complete in all material respects. However, if an issuer has financial statements that have been reviewed or audited by an independent certified public accountant, those statements must be provided.
The annual reporting requirement would continue until one of the following events occurred: (a) the issuer becomes a reporting company; (b) all the issuer’s securities sold under the equity crowdfunding rules are purchased by a third party or repurchased by the issuer; or (c) the issuer liquidates or dissolves its business under state law.
If the company ceases to provide annual reports, then it would be required to file a notice of termination of its annual reporting obligation to the SEC (Form C-TR).
Advertising and Issuer Communication Restrictions
Issuers are prohibited from advertising the terms of an offering, “except for notices which direct investors to the funding portal or broker.” Equity crowdfunding rules describe the acceptable content of such notices, which can include no more than:
- A statement that the issuer is conducting an offering and the terms of the offering;
- The name of the intermediary through which the offering is being conducted and a link directing the investor to the intermediary’s platform; and
- Factual information about the issuer, including its name, address, phone number and website, the e-mail address of a representative of the issuer, and a brief description of the business of the issuer.
Other Crowdfunding Issues
While most U.S. companies are eligible to participate in the new equity crowdfunding offerings, certain companies will not be eligible to engage in crowdfunding transactions under the new rules, including:
- Non-U.S. companies.
- Companies that are disqualified under Regulation Crowdfunding disqualification rules (modeled on the Rule 506(d) “bad actor” rules under Regulation D).
- Companies that are reporting companies under the Securities Exchange Act of 1934, as amended.
- Companies that are delinquent in filing the ongoing reports required by the equity crowdfunding rules.
- Companies that have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company.
Resale Restrictions on Crowdfunded Securities
Crowdfunded securities lack the flexibility of securities sold by a public company because there is no readily accessible public market. As a result, crowdfunded securities are subject to restrictions and cannot be sold at any time, like securities in a publicly-traded company. Furthermore, crowdfunded investors cannot resell crowdfunded securities for one (1) year, unless the securities are transferred, but only in certain situations.
Crowdfunded securities may only be transferred: (1) to the company that issued the securities; (2) to an accredited investor; (3) to a family member; (4) to a trust controlled by the investor or created for the benefit of a family member; (5) in connection with a death, divorce or other similar circumstance; or (6) as part of an offering registered with the SEC.
Because of these and other restrictions, potential investors must be certain that they are able to forgo access to the funds invested in a crowdfunded offering.
Part 3 of this Article will summarize the new equity crowdfunding rules and discuss the takeaways, including whether this is a worthwhile endeavor for small companies seeking to raise up to $1 million.
To read Part 1, CLICK HERE.
For more information on equity crowdfunding and the new rules, please do not hesitate to contact us.
This article was also featured in Legal Ink Magazine.