Crowdfunding - Is this the deal for you?

By: Robert Hawn

If you are an emerging growth high technology start-up, or a closely-held small business, you’ve heard of crowdfunding. Crowdfunding is commonly used to describe an approach to fund raising over the internet, often characterized by small investment amounts by large numbers of people. Recently, the Securities and Exchange Commission enacted its Regulation Crowdfunding. You can find all 685 pages of the release discussing the Regulation, and the Regulation itself, at https://www.sec.gov/rules/final/2015/33-9974.pdf. In this blog, we’ll focus on the requirements concerning issuers.

Under the Regulation, an issuer can raise a maximum of $1,000,000 through crowdfunding in any 12-month period from any person. The offering can’t be conducted by your company directly, however. Instead, it has to be conducted through a broker-dealer or online portal registered with the SEC and a member of the Financial Industry Authority, or FINRA, or other national securities association registered with the SEC. To see if a broker-dealer is properly registered with FINRA, check http://brokercheck.finra.org/, and to check if a portal is properly registered with FINRA, check http://www.finra.org/about/funding-portals-we-regulate.

There are some eligibility requirements that can disqualify an issuer. These include, among others, companies that don’t have a specific business plan (or whose plan is to engage in a merger or acquisition with an unidentified company), issuers that violate so called “bad boy” rules, and companies that have failed to satisfy annual reporting required by Regulation Crowdfunding.

One major requirement facing issuers under the Regulation is the need to prepare a disclosure statement. Although not as extensive as the type of statement required for an SEC registered offering, the requirements are significant. Items that must be disclosed pertain to the offering itself as well as the issuer. Offering related items include, among other things, the desired amount of the offering, the deadline for reaching it, whether investments over the desired offering amount will be accepted, the price of the securities, how the proceeds will be used, and material risks associated with the investment. Issuer related items include, among other things, a description of the business and its financial condition, information about 20% owners, members of the Board of Directors of the issuer, and officers, information concerning transactions between the issuer and related parties, and a description of the issuer’s ownership and capital structure.

The disclosure statement must also include financial statements prepared in accordance with generally accepted accounting principles as applied in the US. The financials must cover the shorter of the immediately preceding two fiscal years or the period since inception. The review the financials have to undergo depends on the amount of the offering:

  • If the current offering plus previous offerings under the Regulation are $100,000 or less, the financials must be certified by the principal executive officer and accompanied by certain information from the issuer’s tax returns (but need not include the tax returns themselves.
  • If the current offering, plus previous offerings under the Regulation, are more than $100,000 but less than $500,000, the financials must be reviewed by a CPA.
  • If the current offering, plus previous offerings under the Regulation, are over $500,000, the financials must be audited. If, however, the issuer has not previously sold securities in reliance under the Regulation, the financials must be reviewed by a CPA.

Keep in mind that there are no exceptions to these requirements, even for very early stage companies. So, if your company has just been formed, and you want to raise over $500,000, you’ll need to provide audited financials.

The amount the issuer can sell to an individual investor is limited. My next blog will discuss the specific investor limitations.

Advertising the offering is, not surprisingly, very limited. An issuer can publish a notice advertising the offering terms similar to “tombstone” ads. The notice must include the address of the funding portal or broker-dealer who is assisting with the offering.

In addition to the initial disclosure documentation, an issuer must file annual reports with the SEC and provide them to investors. The annual reports must contain much of the same information required under the initial disclosure document. Once the issuer becomes a reporting company under the Exchange Act, there is no further need to provide the annual reports required by the Regulation. The rules under which a crowdfunding issuer becomes subject to the reporting obligations under the Exchange Act have been relaxed if the issuer is current on its annual reporting obligations, uses a registered transfer agent, and has less than $25 million in total assets.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

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