Starting on May 16, 2016, entrepreneurs will be given unprecedented access to capital. For the first time in the history of federal securities regulation, companies will be allowed to take investments – i.e., sell “securities,” such as equity — to the crowd without regarding to investor sophistication. This expansion of the funding universe for cash-starved businesses is the heart and soul of the Jumpstart Our Business Startups (JOBS) Act of 2012, designed to spur job creation through development of new businesses made possible by fundamental changes in the regulation of private securities offerings. Prior to the JOBS Act, federal and state securities laws did not allow you to conduct crowdfunding offerings – offerings to the public – without registering the offering with the Securities and Exchange Commission in the same way an initial public offering (IPO) is registered with the SEC.
Because “equity crowdfunding” involves selling securities, there are many regulations that come into play, and there may be significant personal liability for violating these regulations. In this post, we cover the basic requirements of equity crowdfunding under the new rules under Title III of the JOBS Act. In another post, we’ll discuss the new methods of raising capital made possible by the JOBS Act and the differences among Titles II, III and IV.
Title III of the JOBS Act: Regulation CF – Equity Crowdfunding
The new rules under Title III are contained in Regulation CF. Under Regulation CF entrepreneurs may raise up to $1 million during any 12 month period from anyone subject to certain dollar limits on the amount an investor may invest. There is no requirement that the investor be accredited or sophisticated. If the investor’s net worth or income is below $100,000, he or she is subject to an investment cap of the greater of: $2,000 or 5% of the lesser of the investor’s annual income or net worth. If both net worth and annual income are at least $100,000, the investment cap is 10% of the lesser of the investor’s annual income or net worth, not to exceed an amount sold of $100,000. These caps reflect the aggregate amount an investor may invest in all offerings under Regulation CF in a 12-month period across all issuers.
An offering statement is required to be made available to prospective investors, and it must contain general information about the issuer, officer and directors and significant shareholders, the intended use of proceeds, the company’s ownership and capital structure and financial statements for the two most recently completed fiscal years. If the offering amount is greater than $100,000 but less than $500,000, the financial statements must be reviewed by an independent accountant. If the offering amount is greater than $500,000, the financial statements must be audited, unless the company is conducting its first Regulation CF offering, in which case the financial statements need only be reviewed.
The offering statement must be filed with the SEC, but it is not reviewed by them. Once the offering statement is filed with the SEC, a process likely to be provided as a service by the internet portal, the offering may immediately commence and the company may accept investor subscriptions.
A significant limitation under Regulation CF is that all offerings must be conducted through a single internet portal, which must either be registered with the SEC as a broker-dealer or as a new form of regulated entity, a “financing portal.” Another significant limitation under Regulation CF is that “general solicitation” is prohibited outside of the portal. All communications and other forms of solicitation must be limited to the registered users of the portal through communication channels provided by the portal. The only exception to the prohibition on general solicitation is a notice of the securities offering that may direct interested persons to the portal, where potential investors may register as a member of the portal to gain access to the Company’s soliciting materials and communications.
A final limitation of any securities offering relates to compensation of persons involved in the solicitation of securities. After all, the old adage, “securities are sold, not purchased,” is as true (if not more true) today than it was in 1933 when Congress first regulated the sale of securities. Companies must be careful when they engage individuals, even employees, to assist in the company’s securities solicitation efforts, those persons may be required to register as broker-dealers with the SEC or state securities administrators.
According to the SEC, “finders,” “business brokers,” and other individuals or entities that engage in finding investors or customers for, making referrals to, or splitting commissions with registered broker-dealers, investment companies (or mutual funds, including hedge funds) or other securities intermediaries. In order to determine whether any of these individuals (or any other person or business) is a broker, the SEC looks at the activities that the person or business actually performs.
May 26: Crowdfunding and the JOBS Act
The JOBS Act legalized equity crowdfunding and private peer-to-peer lending, created a new regime for regulating “mini-IPOs,” and paved the way for the SEC to create new sources of liquidity for early-stage investors through secondary “venture markets.” The law already has spawned new and innovative financial companies dispensing capital to startup and growing businesses. Since its enactment, the JOBS Act has been described as “democratizing” access to capital by “disintermediating” Wall Street from the process of raising capital. Once the SEC’s newly issued rules for equity crowdfunding become final on May 26, everyday people will be able to join crowds of other small investors to directly fund startup businesses that pique their interest.
About the Author
Mark Hiraide is the SBEC board secretary. Mark is a corporate and securities partner with Mitchell Silberberg & Knupp (MSK) in Los Angeles. Mark previously partnered with the late Lee Petillon (co-founder of SBEC) for 20 years at the securities-law boutique Petillon Hiraide LLP. He is an authority on the federal JOBS Act, having testified before a U.S. Senate subcommittee evaluating the law designed to help startups raise money. He is the author of a book on crowdfunding just published by Thomson Reuters. And he is working with the California Legislature to pass a state crowdfunding law he drafted.