This is a guest post from Fox Rothschild attorney Michael Harrington.
The SEC issued proposed rules and forms last month that would finally implement Title III of the JOBS Act, which created an exemption from registration under the Securities Act of 1933 for certain “crowdfunding” securities offerings conducted through “crowdfunding intermediaries.”
In other words, the government agency charged with overseeing capital investment is creating a structure for average people — not just accredited investors — to buy equity in companies so that they might own a portion of their future success and failure.
The exemption remains unavailable until the SEC finally adopts these implementing rules, but this most recent step means that final rules are coming shortly.
Under the proposed SEC rules, issuers who intend to conduct a crowdfunding offering are required to file certain information with the SEC and provide this information to investors, potential investors and the crowdfunding intermediary that they’ll be using — there are many vying for dominance, but Kickstarter is a popular example.
In addition, an issuer — for our purposes, let’s think of them as a startup company, but other groups will get involved — is required under the proposed rules to prepare and file a Form C on EDGAR (the Electronic Data-Gathering, Analysis, and Retrieval system, which is used by those required by law to file forms with the SEC) before the offering commencement. Among other things, Form C requires the reporting to the SEC of the following:
- information on the issuer, directors and officers, owners (if they own 20 percent or more of the issuer),
- business plan,
- intended use of proceeds,
- targeted offering amounts,
- offering price and how it was determined,
- information about the intermediary being used,
- and additional information set forth in the proposed rules.
The implementing rules also require disclosure of certain information not required by the JOBS Act, such as the number of current employees of the issuer, risk factors relating to the offering, the issuers of debt position and related party transactions, among other information.
The SEC’s implementing rules follow the original statutory framework and require an equity crowdfunding issuer to provide the following financial information:
- For offerings of $100,000 or less, US GAAP (generally accepted accounting principles) financial statements for the two most recently completed fiscal years or shorter period during which the issuer has been operating as well as filed income tax returns for the most recently completed fiscal year.
- For offerings between $100,000 and $500,000, CPA reviewed US GAAP financial statements along with the CPA’s review report; and for offerings over $500,000, CPA audited US GAAP financial statements.
An issuer, like a tech startup, would also be required to provide a narrative discussion of its financial condition covering, among other things, historic results of operations and liquidity and capital resources. In many respects, this is similar to a MD&A (Management Discussion and Analysis, which provides a narrative explanation, through the eyes of management, of how an entity has performed in the past, its financial condition, and its future prospects), but is not intended to be as lengthy or detailed.
The proposed regulations also require each issuer to do the following:
- file with the SEC and post to its website an annual report within 120 days of the end of each fiscal year that discloses information about ongoing business and capital-raising activities.
- In addition, issuers are restricted in their ability to advertise their crowdfunding offering only through a print or electronic notice containing specific limited information.
- The notice must direct potential investors to the crowdfunding intermediary platform being utilized, where these investors could then access additional information about the offering.
- However, under the proposed rules, there would be no restriction on an issuer’s ability to communicate with investors or potential investors on the intermediary’s platform, or make communications that do not refer to the terms of the offering. For example, an issuer can advertise its products or services so long as it does not refer to its crowdfunding offering in the advertisement.
The SEC’s proposed rules clarify issues arising from the $1 million capital raise maximum prescribed by Congress in Title III of the JOBS Act as well as the per investor maximums. Under the proposed rules, only securities sold in the crowdfunding offering would count toward an issuer’s $1 million capital raise maximum. The proposed rules also permit crowdfunding issuers to rely on the efforts of crowdfunding intermediaries to determine whether an investor has reached the per investor limits prescribed by Title III of the JOBS Act.
The SEC is seeking public comment on the proposed rules for a 90 day period. Once the public comment period concludes, we should expect to receive final regulations that implement equity crowdfunding. Once this happens, a new era in raising capital for entrepreneurs and start-up enterprises begins.
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