Last week, the Securities Exchange Commission finally adopted regulations to permit equity-based crowdfunding at the federal level. These regulations will be effective in 6 months. This is a monumental change in federal policy that many entrepreneurs and business owners have been waiting on for years and will allow small businesses across the country to solicit to the masses AND receive funds from the masses in exchange for equity ownership in their business. Equity-based crowdfunding at the federal level began as part of Title III of the Jumpstart Our Business Startups (“JOBS”) Act of 2012. In 2013, the SEC proposed regulations to implement equity-based crowdfunding but it took them almost three years to adopt the regulations.
Earlier this year, the SEC approved and ratified Title IV of the JOBS Act, which implemented Regulation A+. Some commentators had been referring to this as equity-based crowdfunding at the federal level – that simply was not true. Other versions or forms of crowdfunding have been utilized for a number of years, including rewards-based crowdfunding, donation-based crowdfunding, and debt-based crowdfunding, but those versions of crowdfunding are inherently different than equity-based crowdfunding. With equity-based crowdfunding, an investor provides capital in return for an equity or ownership in the business/company that received the capital. Equity-based crowdfunding has been approved by various states over the last few years, but that was only helpful for a business owner who was not going to cross state lines to solicit investors in a state that approved equity based crowdfunding. At the federal level, prior to this crowdfunding exemption, the only SEC exemption that allowed a business owner to solicit to the masses was under what’s called a Rule 506(c) offering, but funds could only be received from what is known as an accredited investor. The reality is that very few qualify as an accredited investor. Now, a business owner can solicit to AND receive from funds from the masses. This is a huge opportunity for a small business owner to raise capital for their business. Here are some details of the benefits and requirements of the recently adopted rules governing SEC approved equity-based crowdfunding.
Under this crowdfunding exemption, a business can solicit investors across the country and receive capital up to $1 million per year. However, each individual investor also has annual investment limits that range from $2,000 to $100,000 per year, depending on their net worth and/or annual income. It should be noted that this individual investor limit is an investment limit into all crowdfunding offerings during the year. So a business could use this exemption to raise up to $1M per year without being limited to issuing ownership/equity only to accredited investors. The main requirements in order to solicit for and receive capital through federal equity-based crowdfunding are:
- Funding Portal. You may only solicit for and receive capital through an SEC registered crowdfunding portal that is a member of the national securities association. You will want to do your due diligence in selecting a crowdfunding portal because currently there are portals that assist business owners either under one of the state exemptions, or that offer a different form of crowdfunding, e.g., rewards-based, donation-based, or debt-based, rule 506(c) offerings for accredited investors, or that offer federal equity-based crowdfunding even though it hadn’t been officially adopted by the SEC until just a few days ago. Therefore, you will want to make sure you use a crowdfunding portal that is authorized to offer federal equity-based crowdfunding and that is registered with the SEC. Funding portals will be able to register with the SEC effective January of 2016.
- Formation and Disclosure Documents. You will need to have the appropriate documentation in place for your business AND the appropriate disclosure documentation to be able to solicit for and receive funds through SEC approved equity-based crowdfunding. This will include:
- Formation documents to establish your business, including the details surrounding how an investor would obtain ownership in your company. For example, the document that will govern your business, e.g., operating agreement, will need to be drafted in a manner that contemplates and allows investors to receive partial ownership in your company.
- The price of the security (ownership in your company), the total amount of capital you intend to raise, the deadline to reach the target offering amount, etc.
- Disclosure of your company’s financial condition, including financial statements of your company.
- A description of your business and how the raised capital will be used including potential risks and other disclosures associated with your business.
- Disclosure of the owners and officers of your company.
Note: We don’t recommend that you go through an online company or even a funding portal to obtain these documents as neither should be giving legal advice that would often be necessary in connection with these documents. Additionally, on-line document companies do not offer documents that will comply with the rules outlined above.
- Independent Financial Review. Depending on the amount being raised, the financial documents for your company would need to be accompanied by information from the company’s tax returns and reviewed by an independent public accountant or audited by an independent auditor. However, first time offerings of between $500,000 and $1M would be permitted to provide accountant reviewed financials rather than audited financials.
- Annual SEC Filing. A company that is relying on this federal crowdfunding exemption will be required to file an annual report with the SEC and provide it to its investors.
For business owners who have previously raised capital under what is known as a Regulation D exemption, e.g., Rule 505, 506(b), or 506(c), they will welcome the ability to solicit AND to receive funds from non-accredited investors. Our office is available to help you through the process of raising capital through this newly adopted federal crowdfunding exemption. We can assist in structuring the offering and can provide the documents and filings necessary to appropriately rely on the new crowdfunding exemption.