Crowdfunding and The JOBS Act
The JOBS Act and "Crowdfunding"
The term “crowdfunding” generally describes campaigns to raise relatively small amounts of money from large numbers of people. Modern crowdfunding started with campaigns soliciting donations for social causes or new business ventures. In these early crowdfunding campaigns, individuals donated to a cause or company in exchange for a token of appreciation – for example, a t-shirt, a first opportunity to purchase a product, or a movie production credit.1 In an “equity crowdfunding” campaign, individuals purchase “securities,” as that term is defined under the Securities Act of 1933 (the “1933 Act”) and Securities Exchange Act of 1934 (the “1934 Act”), as amended.2 Consequently, the 1933 Act’s registration requirements relating to the offer and sale of securities as well as its civil liability provisions -- and the anti-fraud provisions under both acts -- apply to equity crowdfunding offerings. Prior to the JOBS Act, private offering exemptions from the 1933 Act’s registration requirement did not allow for equity crowdfunding, which, by definition, involves a public offering to the crowd.
The JOBS Act fundamentally changed the rules relating to private securities offerings by allowing companies to conduct certain types of public offerings – to raise money from the “crowd” – without registering the securities offering with the SEC. The JOBS Act effectively created three new exemptions from SEC registration for three types of public or “crowdfunding” offerings.
The first exemption, promulgated under Title II of the JOBS Act, is limited to “accredited” investors only.3 It relies on rule 506 of Regulation D and, therefore, there is no dollar limit on these offerings and very few other limitations. In addition, the JOBS Act eliminated the 90-year-old ban on “general solicitation” for this type of offering, allowing entrepreneurs to take out advertising, create websites, etc., to reach members of the general public. This exemption became effective on September 23, 2013.
The second exemption, promulgated under Title IV of the JOBS Act and effective in September 2013, requires a review, or “qualification,” of the offering by the SEC but, once qualified, may be sold to anyone subject to certain individual investment limits. This exemption relies on a set of SEC regulations commonly referred to as “Regulation A+.” It has two tiers, one with a maximum fundraising limit of $20 million and the other $50 million. It became effective on June 15, 2015.
The third exemption, the subject of this Commentary and Analysis, is Regulation CF promulgated under Title III of the JOBS Act. The final rules for taking advantage of this exemption will take effect on May 16, 2016.
Contents of Title III of the JOBS Act
The JOBS ACT, TITLE III—CROWDFUNDING, includes the following sections:
Sec. 301. Short Title.
Sec. 302. Crowdfunding Exemption.
Sec. 303. Exclusion of Crowdfunding Investors from Shareholder Cap.
Sec. 304. Funding Portal Regulation.
Sec. 305. Relationship with State Law.
The following summarizes the salient aspects of Regulation CF promulgated by the SEC under Title III of the JOBS Act:
- A company may raise in any 12-month period a maximum aggregate amount of $1 million in equity crowdfunding offerings conducted through a registered broker-dealer or financial portal.
- Individual investors, in any 12-month period, are permitted to invest in the aggregate across all crowdfunding offerings up to:
- If either their annual income or net worth is less than $100,000, then the greater of:
- $2,000 or
- 5 percent of the lesser of their annual income or net worth.
- If both their annual income and net worth are equal to or more than $100,000, then 10 percent of the lesser of their annual income or net worth but in no case may the investment exceed $100,000.
- If either their annual income or net worth is less than $100,000, then the greater of:
- Issuers must disclose the following:
- Information about officers and directors as well as owners of 20 percent or more of the issuer;
- A description of the issuer’s business and the use of proceeds from the offering;
- The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the issuer will accept investments in excess of the target offering amount;
- Certain related-party transactions;
- A discussion of the issuer’s financial condition; and
- Financial statements of the issuer that are, depending on the amount offered and sold during a 12-month period, accompanied by information from the issuer’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. An issuer relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements unless financial statements of the issuer that have been audited by an independent auditor are available.
- Issuers are required to amend the offering document during the offering period to reflect material changes and provide updates on the issuer’s progress toward reaching the target offering.
- Issuers are required to file an annual report with the SEC and provide it to investors.
- All domestic companies may conduct crowdfunding offerings under Regulation CF, except: non-U.S. companies; companies that already are registered and reporting with the SEC; certain investment companies; companies that are disqualified under Regulation CF’s disqualification rules; companies that have failed to comply with the annual reporting requirements under Regulation CF during the two years immediately preceding the filing of the offering statement; and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.
- The crowdfunding offering must take place through an SEC-registered broker-dealer or “funding portal,” which must:
- Provide investors with educational materials;
- Take measures to reduce the risk of fraud;
- Make available information about the issuer and the offering;
- Provide communication channels to permit discussions about offerings on the platform; and
- Facilitate the offer and sale of crowdfunded securities.
- State securities “blue sky” regulations are preempted.
- Securities sold generally cannot be resold for one year.
- Securities sold do not count toward the threshold that requires an issuer to become a registered public reporting company with the SEC.
1. Many of the 9,522 people who had contributed to virtual-reality pioneer Oculus’s non-equity crowdfunding campaign on Kickstarter may have been surprised to learn that they would not share in Oculus’ gains two years later when Facebook announced in March 2014 that it was acquiring Oculus for $2 billion. INDIEGOGO IS GETTING READY FOR EQUITY CROWDFUNDING.↵
2. See Section 2(a)(1) of the 1933 Act, 15 U.S.C. § 77b(1), and Section 3(a)(10) of the 1934 Act, Id. § 78c(a)(10). The definition of “security” includes not only stocks and bonds, but an “investment contract” that is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party. . . . ” SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946).↵
3. An “accredited investor” can be an individual or an entity. Individual investors (or in the SEC’s words, a “natural person”) is accredited if he or she:
• earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
• has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
On the income test, the person must satisfy the thresholds for the three years consistently either alone or with a spouse, and cannot, for example, satisfy one year based on individual income and the next two years based on joint income with a spouse. The only exception is if a person is married within this period, in which case the person may satisfy the threshold on the basis of joint income for the years during which the person was married and on the basis of individual income for the other years.
Entities are accredited investors if they are:
• any trust with total assets in excess of $5 million not formed to specifically purchase the subject securities, whose purchase is directed by a sophisticated person; or
• any entity in which all of the equity owners are accredited investors.↵
4. The term “issuer” refers to the entity in which the investment is made; it is, therefore, the entity that offers, sells and issues its securities. See Section 2(4) of the Securities Act of 1933.↵
Written by: Mark T. Hiraide, Partner, Mitchell Silberberg & Knupp LLP. Excerpted from Crowdfunding: Practical Guide to the SEC's Final Rules for Raising Capital, available for purchase on ThomsonReuters.com. This practical guide focuses on you, the entrepreneur, and your legal counsel and the information that will help you take full and safe advantage of the crowdfunding approach to raising capital.