CLIENT ALERT: SEC Issues a Balanced Proposal for Equity-Based Crowdfunding Transactions Over the Internet
On October 23, 2013, the U.S. Securities and Exchange Commission (the “SEC”) proposed for comment amendments to the Securities Act of 1933, as amended (the “Securities Act”), to implement “Regulation Crowdfunding” in accordance with Title III of the Jumpstart our Business Startups (JOBS) Act.
The proposed amendments (i) create rules governing the offer and sale of securities through an Internet website, including individual investment limits and the aggregate offering size for a crowdfunding transaction and required disclosures that must be made by companies before commencing a transaction (see new Section 4(a)(6)), and (ii) provide a framework for the regulation of registered funding portals and broker-dealers that companies are required to use as financial intermediaries in the offer and sale of securities in connection with a crowdfunding transaction (see new Section 4A). The SEC has also proposed an amendment to Section 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), to exempt securities sold in a crowdfunding transaction from counting towards the number of shareholders that would require SEC issuer registration.
The SEC is seeking public comment on Regulation Crowdfunding for a 90-day period following publication of the proposed rules in the Federal Register. Companies cannot use the proposed crowdfunding rules until the SEC adopts final rules, anticipated to occur in the first quarter of next year.
For the ease of review, we have set forth below a term sheet summary of the details of the SEC’s Regulation Crowdfunding proposals:
|Regulation Crowdfunding: Summary of Terms|
|Maximum Capital Raise:||An issuer can raise gross offering proceeds of no more than $1 million in any rolling 12-month period.|
|Number of Investors:||Unlimited, as to both accredited and non-accredited investors, subject to maximum individual investment limits and the aggregate offering size for a crowdfunding transaction.|
|Maximum Investment per Investor:||
The following information must be filed with the SEC, and provided to potential investors and the financial intermediary, before commencement of a crowdfunding transaction on a new Form C Offering Statement:
The following supplemental information must be filed on a new Form C-U Progress Update:
A financial intermediary is required in all crowdfunding transactions. The intermediary may be a registered broker-dealer or a funding portal, and the offering must be conducted exclusively online through a platform operated by that one intermediary. Among an intermediary’s requirements are to make information available about the company and the offering, provide investors with educational materials and take measures to reduce the risk of fraud.
As an intermediary, a funding portal is prohibited from soliciting purchases or compensating persons based on the sale of securities displayed on its website, offering investment advice or making recommendations, or holding or handling investor funds or securities.
|Simultaneous Exempt Offerings:||
A company may separately conduct crowdfunding offerings at the same time as offerings made pursuant to other Securities Act exemptions (for example, with general solicitation under Rule 506(c)).
Under the SEC’s proposal, capital raised through offerings other than crowdfunding will not be counted in determining the aggregate amount sold in reliance on the crowdfunding exemption.
|Ongoing Disclosure Obligations:||
Annual reports disclosing information similar to the information required in the Offering Statement, including disclosure about the company’s financial condition, must be filed by the company with the SEC within 120 days after the company’s fiscal year end and published to the issuer’s website. The annual report requirement would be applicable until such time as the issuer becomes subject to Exchange Act reporting, all securities sold in the offering have been retired or the company winds down its operations. No other periodic or current reports are required.
Crowdfunded securities cannot be transferred by the purchaser for one year after the date of purchase, except when transferred:
Companies themselves may not advertise the terms of the offering, except for permitted notices that direct potential investors to the financial intermediary.
Certain companies will not be eligible to avail themselves of the crowdfunding exemption, including:
The “bad actor” disqualification would also apply to the financial intermediary.
|State Securities Laws:||
State registration (“blue sky”) and offering requirements are pre-empted by the JOBS Act, but remain subject to state anti-fraud enforcement.
Having been drafted by the SEC Division of Corporation Finance’s Office of Chief Counsel, Regulation Crowdfunding reflects a deliberate attempt to balance the need for both a spur to small business capital formation and measures to protect investors from fraud. A primary example of this is the creation of a new “broker-dealer lite” category for crowdfunding intermediaries who must register with the SEC as a funding portal using Form Funding Portal. This form would be accessible to the public in the same way as the broker-dealer Form BD. In turn, a funding portal may display offerings on its platform to a large pool of investors over the Internet, advise companies on the structure and terms of offerings, and provide communication channels (acting as “gatekeepers”) among investors, potential investors and issuers.
As with all financing transaction structures, crowdfunding may be ideal for some companies but not for others. Non-traditional startups and small businesses such as artistic projects, neighborhood shops and new technology ideas have successfully used non-equity crowdfunding sites like Kickstarter, Indiegogo and RocketHub, and can be expected to expand into full crowdfunding under the new rules.
Certain companies and their financial advisors may find that making a crowdfunding transaction a component of a larger capital-raising strategy together with another offering pursuant to a Securities Act exemption (such as a Rule 506(c) private placement utilizing general solicitation) or in conjunction with the exemption for public offerings under proposed Regulation A+, presents an attractive dual-track financing plan. Companies — maybe even more traditional corporate issuers — may favor crowdfunding as it spreads out ownership among highly disparate retail investors and, in preparation for a stock exchange listing, assists companies seeking to obtain at least 400 round lot holders. Interestingly, the SEC has also discussed proposals to facilitate the creation of “venture exchanges” to introduce liquidity for smaller company investments.
Crowdfunding has clearly been one of the most talked about JOBS Act topics. Along with new Rule 506(c) for generally soliciting accredited investors, crowdfunding’s use of the Internet allows a company to offer its securities, in a manner that is fair to all investors, beyond its immediate geographical area and its existing shareholder and supporter base, and to obtain financing in a timeframe sooner than that needed for a registered SEC offering.
We will continue to monitor these proposed rules. Please do not hesitate to contact the Olshan attorney with whom you regularly work or either of the attorneys listed below if you would like additional information or require guidance in entering the equity-based crowdfunding space.