The New Equity Crowdfunding Rules

Two weeks ago the SEC finally published proposed rules for equity crowdfunding, pursuant to Title III of the JOBS Act. Currently the rules are in a 90-day public comment period, after which the SEC may choose to adopt the rules as written, adopt amended rules, or extend the comment period — only once rules are formally adopted by the Commission will equity crowdfunding be permissible. The proposed rules tack quite closely to the provisions of Title III of the JOBS Act; however, the regulatory requirements in Title III were in and of themselves quite complicated for small startups to have to abide by. By way of summary, the proposed equity crowdfunding rules include: – Exemption not available to: – Sole proprietorships (must be an organized business) – Non-U.S. businesses – Companies already subject to other SEC reporting requirements – Investment companies – Companies who have failed to comply with equity crowdfunding rules – Companies without a business plan – Issuers may not raise more than $1 million in any 12 month period – Investors have limits on investment in any 12 month period: – the greater of $2000 or 5% of the greater of annual income or net worth if under and up to $100,000 – the greater of 10% of net worth or annual income if over $100,000 – annual income and net worth are calculated according to accredited investor guidelines – Issuers must conduct their offering through an online portal (subject to their own regulations under the rules) – May only use one portal per offering (cannot list the offering on multiple portals) – Issuers may not generally solicit, except to list the identity and location of the issuer and the basic terms of the offering, and direct prospective investors to the online portal where the offering is listed – Communication with prospective investors must occur through the portal – Issuers may only compensate promoters who promote through the portal (and must disclose such compensation) – Issuers must File Form C, which requires information such as: – The identity, location, and legal status of the issuer – The identity of directors, officers, and shareholders holding more than 20% equity – Description of the equity structure of the issuer, including the terms and rights of each class of security (in particular the security being offered in the equity crowdfunding offering), how such rights may be modified, and how the rights of the security being offered may be limited, diluted, or qualified by other classes of securities, or impacted by the rights of principal shareholders, and the risks of minority ownership – The target amount of the offering, and the price of the security and how that price was determined – The business plan of the issuer – The intended use(s) of the funds being raised – Financial records, which shall be: – If raising $100,000 or less, the income tax return for the last tax year and financial statements certified by the chief financial officer as true and complete – If raising more than $100,000 but not more than $500,000, financial statements reviewed by a public accountant – If raising more than $500,000, audited financial statements – Filing of updated Form Cs during the offering, and to close out the offering, plus annual Form C updates Given the significant regulatory requirements of the JOBS Act and the corresponding proposed SEC rules, it is likely that equity crowdfunding will be more utilized by startups whose products and services are not as attractive to traditional private equity (read: not tech). In any event, equity crowdfunding will be a tedious and expensive proposition for any company that uses it in light of the reporting requirement of the offering, the ongoing annual reporting requirements, plus the administrative responsibilities that would likely follow with having a not-insignificant number of individual investors.

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