[vc_row type=”in_container” full_screen_row_position=”middle” scene_position=”center” text_color=”dark” text_align=”left” overlay_strength=”0.3″][vc_column column_padding=”no-extra-padding” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ width=”1/1″ tablet_text_alignment=”default” phone_text_alignment=”default”][vc_column_text]This crowdfunding news is too good not to share. *
Until now, un-accredited retail investors (most people) were barred from directly investing in private companies. For the first time in the 82-year history of regulation of securities markets, “retail investors” (i.e., ordinary individuals deemed “unaccredited”) will be able to directly purchase shares in private businesses. This new source of financing has the potential to substantially enlarge the pool of money available to startups (and non-start ups).
To invest in a private business, an investor had to be:
- a qualified institutional buyer
- an “accredited investor” ($1 million net worth or $200,000 in annual income)
- participate in an intrastate offering (if state law allows)
- one of 35 unaccredited investors in an offering to accredited investor
Otherwise, a retail investor had to wait until the private company went public through the registration process. Of course, by that time early stage professional investors were exiting the investment. In today’s world where private companies such as Uber wait until they receive multi-billion dollar valuations before going public, the retail investor has essentially been locked out of the current technology boom and other potentially desirable private companies.
This changed with the Securities and Exchange Commission (the “SEC”) adoption of Regulation CF, which gives effect to the long-awaited Title III of the JOBS Act. The “Jumpstart Our Business Act” became law on April 5, 2012, and was meant to loosen decades-old rules around raising capital.
The SEC has since promulgated many new rules governing offeringsthat have made it easier to go public in the U.S., and to raise private capital. But approving crowdfunding with the participation of un-accredited investors was the most difficult for them because it meant opening up offerings to investors the SEC has long deemed “unsophisticated” and in need of protection through the securities registration process.
This is why it has taken more than three years for the rules to be developed and to become effective, and why they are deemed a radical departure from past practice. Of course, it remains to be seen how this new development will evolve with time.
But every U.S.-based startup (and operating business that needs working capital) should consider a crowdfunding offering as an option to raise early stage capital.
Basic Rules for an Equity Crowdfunding Offering**
Eligibility Requirements:
- A company must be organized in the U.S., privately-owned, and have an ongoing commercial business
- Blank-check and passive investment companies are explicitly excluded
Limit on Capital Raised:
- An issuer may sell up to $1 million of securities in any twelve-month period to investors
- The offering may be conducted with another offering not requiring registration (such as under Regulation A+), but the amounts will be aggregated for purposes of meeting regulatory limits
- The rules do not limit the types of securities that may be offered, and may include preferred stock and debt
Offering Through an Intermediary:
- The offering must be through a registered broker-dealer or a specially-designated funding portal
- Only one intermediary may be used at a time for particular or concurrent offerings
- The selected intermediary’s online platform must be exclusively used so potential investors have access to information, and there is a forum for an exchange of information among potential investors
- Communications with potential investors must also occur through the intermediary’s online platform
- Offline advertising is limited to information that would be contained on a tombstone
Disclosure Requirements:
Company disclosures are set out on “Form C,” which the intermediary would post on its website for potential investors, and which would be filed with the SEC.
The Form C requirements resemble those of a prospectus; or more specifically, those mandated in current Regulation A offerings. They include a description of the business; backgrounds of officers, directors and shareholders owning 20% or more of the stock; use of proceeds; related party transactions, capital structure and financial results.
In addition to factual information, management must provide its “Discussion and Analysis” of the company’s performance, and material trends affecting the business.
After the initial disclosure about the offering, amendments to report material changes in the offering or the company, periodic updates on the offering (such as when half the securities have been sold), and, after the offering, ongoing annual filings, are also required.
Financial Statement Requirements:
Much consideration was given to the financial data that must be provided. The SEC was mindful not to burden young companies with expensive reporting requirements, but nevertheless had to require useful, accurate and objective financial data to aid the investment decision.
The type of financial reports that must be provided depends on the amount to be raised as described below. Financial statements must be prepared in accordance with U.S. GAAP.
? Up to $100,000: Statements prepared by an outside professional are not required, allowing management to use its own financial statements. They must be certified by the CEO. If reviewed or audited financial statements are available, however, they must be provided instead.
? $100,000 to $500,000: financial statements must be prepared by a public accountant, but may be reviewed rather than audited. If audited financial statements are available, they must be provided instead.
? $500,000 to $1 Million: audited financial statements are required except for first-time issuers, who may use financial statements reviewed by a public accountant. If audited statements are available, they must be provided instead.
Issues Related to Potential Investors:
There are limitations as to how much of their income and net wealth retail investors may invest in crowdfunded offerings. The intermediary is responsible for calculating an investor’s limit, but it is important to know them. An investor will be limited to investing over a 12-month period in crowdfunded offerings:
? If both annual income and net worth are more than $100,000, then 10% of the lesser amount, not to exceed $100,000, and
? If either annual income or net worth is less than $100,000, then the greater of $2,000 or 5% of the lesser amount of income or net worth.
With some exceptions, an investor may not transfer her shares for one year. The exceptions are:
- transfers to the issuer
- an accredited investor
- a family member
- an estate
- third parties in a registered offering
With the release, finally, of the much anticipated crowdfunding rules, a grand experiment begins.
It remains to be seen how useful equity crowdfunding as currently designed will prove for raising small amounts of capital. Despite the SEC’s efforts to simplify reporting, startups may nevertheless find the procedural and informational requirements too significant so as to make the scheme impracticable.
Nevertheless, the new rules allowing online platforms to sell stock and unaccredited investors to participate are exciting new developments that depart from past norms. The Rubicon has been crossed and while the new rules may evolve with practice, they are unlikely to be reversed. Crowdfunding for capital raises and unaccredited retail investor participation in private company offerings are likely here to stay.[/vc_column_text][/vc_column][/vc_row][vc_row type=”in_container” full_screen_row_position=”middle” scene_position=”center” text_color=”dark” text_align=”left” overlay_strength=”0.3″][vc_column column_padding=”no-extra-padding” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ width=”1/1″ tablet_text_alignment=”default” phone_text_alignment=”default”][nectar_btn size=”large” button_style=”regular” button_color_2=”Accent-Color” color_override=”#007581″ icon_family=”none” url=”mailto:team@thehabitsofprofit.com” text=”Contact The Habits of Profitability™ Team” margin_top=”20″][/vc_column][/vc_row]