AventinusGlass

The Jumpstart Our Business Startups Act (the JOBS Act) was put in place with the purpose of doing what the name suggests. One portion of the Act would allow companies to raise money via crowdfunding without registering the offering with the SEC. Small, often interesting/innovative, businesses, such as craft breweries, have been using crowdfunding platforms to raise money by offering “investors” goods and swag in return for the “investment”. “Investment” is used in quotations because it has really been more of a donation. Those who contributed to these endeavors gained no equity ownership in the company seeking to raise funds. On Wednesday, the SEC issued more than 500 pages of  proposed rules, discussion and analysis that would permit companies to offer and sell securities by way of crowdfunding. The public now has 90 days to comment on the proposed rules. After reviewing the proposed rules, this blog rehashes some of the key provisions and addresses some issues likely to be raised during the public comment period.

The proposed rules will cap the aggregate amount that may be raised under the crowdfunding exemption to $1 million in any 12-month period. Some of the initial public comments demonstrate disappointment with the $1 million cap and suggest it will stifle start-ups that may not want to use other methods to raise funds. The SEC, at least, is looking for comment on whether the $1 million cap should be net of fees charged by the intermediary to host the offering on the intermediary’s platform.

One of the major goals that the SEC and investor advocates have for crowdfunding is to protect potential investors from digging themselves into a financial hole. The proposed rules seek to accomplish this goal by placing the following investment limits upon investors:

Investors, over the course of a 12-month period, would be permitted to invest up to:

    • $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
    • 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000.  During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding

With that in mind, the discussion of the proposed rules noted that “we believe that the appropriate approach to the investment limitations … is to provide for an overall investment limit of $100,000 and, within that limit, to provide for a “greater of” limitation based on an investor’s annual income or net worth.”

However, there does not appear to be much in the proposed rules that will keep an individual investor from exceeding the cap, as it appears as though investors will essentially be able to self-verify their income limits.

The proposed rules would require that an intermediary have a reasonable basis to believe that the investor satisfies the investment limitations before permitting an investor to make an investment commitment on its platform, but further note that an intermediary may rely on an investor’s representations concerning compliance with investment limitation requirements. Perhaps those submitting public comment will consider ways to require independent verification of whether investors have exceeded, or will exceed, the caps imposed upon investors.

Additionally, the proposed rules demonstrate the SEC’s preference to keep issuers from simultaneously conducting multiple crowdfunding offerings on more than one platform. The SEC believes this “would diminish the ability of the members of the crowd to effectively share information, because essentially, there would be multiple “crowds.” The SEC similarly notes that allowing an issuer to conduct offerings on more than one crowdfunding platform would make it more difficult to ensure that an issuer does not exceed the $1 million aggregate offering limit.

The proposed rules will also require a number of disclosures to be made by the issuer in an effort to provide information that could serve to protect investors. Some of the disclosures that issuers will be required to make include:

i) a description of the terms of the securities of the issuer being offered and each other class of security of the issuer…;

(ii) a description of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers of the securities being offered;

(iii) the name and ownership level of each existing shareholder who owns more than 20 percent of any class of the securities of the issuer;

(iv) how the securities being offered are being valued…; and

(v) the risks to purchasers of the securities relating to minority ownership in the issuer, the risks associated with corporate actions, including additional issuances of shares, a sale of the issuer or of assets of the issuer, or transactions with related parties.

Issuers will also be required to disclose financial statements and, when seeking to raise $500,000 or more, will be required to disclose audited financial statements. Concern about these requirements is already apparent. First, start-ups generally won’t have financial statements. Second, the audit requirement is an added financial burden that small companies and start-ups may seek to avoid. The SEC is seeking comment about whether issuers with no operating history or in existence for fewer than 12 months should be exempted from the requirement to provide financial statements.

Last month, rules allowing general solicitation went into effect allowing fundraisers, for the first time, to advertise the fact that they were raising money. Still, this exemption only allows accredited investors (person with net worth that exceeds $1 million or income exceeding $200,000 in each of the two most recent years) to participate in the fundraising and brings with it a heightened duty to verify the status of each accredited investor. CrowdBrewed has since gone live, allowing craft brewers to utilize that platform to seek investment from accredited investors. Soon, CrowdBrewed and sites like it will provide brewers (and other small business ventures) with a platform to raise funds by selling equity capital to other interested investors.