by: Matthew Andersen, Web Editor
After much anticipation, the Securities and Exchange Commission (“SEC”) has finally proposed new rules for equity crowdfunding. These new rules will allow investors to purchase stock in companies over the Internet through a crowdfunding exchange. This will assist the SEC in regulating any business that chooses to fund its venture through the Internet. The SEC proposed the new rules on October 23, 2013, even though they were supposed to be proposed by December 31, 2012, and will be followed by a 90-day comment period, and an SEC meeting to give final approval. Experts are predicting the proposed crowdfunding rules will be finalized by February of 2014.
The SEC was required by law to adopt the new crowdfunding rules pursuant to the Jumpstart Our Business Acts of 2012 (“JOBS Act”). The intent of the JOBS Act, which passed 390-26 in the House of Representatives and 73-26 in the Senate, was to establish a foundation for small businesses and start-ups to raise capital through crowdfunding, which is becoming the predominant means of raising capital through the Internet. Furthermore, the JOBS Act is a means to ease restrictions on raising capital, from IPOs to start-up funding. Although most of the provisions of the JOBS Act have been implemented, the crowdfunding provision was the last to be implemented, because of a myriad of rulemaking delays.
Crowdfunding has become very popular in recent years as a way for anybody to raise money to fund projects, causes, businesses, and anything else imaginable. Websites like Kickstarter, Indiegogo, and Prosper have become the largest platforms for crowdfunding, but more-and-more platforms are popping up daily.
The best overview of the proposed crowdfunding rules has come from JDSupra:
The proposed rules are extensive and cover areas such as:
- Limitations on, and method of calculating, the amount of funds an issuer can raise in crowdfunding transactions
- Limitations on the amount an individual investor may invest in such offerings based on their income and assets:
- Investors with an annual net income or net worth of less than $100,000 can invest up to 5 percent of that amount, or $2,000, whichever is more, every 12 months.
- Investors with an annual income or net worth exceeding $100,000 can invest up to 10 percent of that every 12 months.
- Disclosure obligations of the company raising funds, which would require the company to prepare an offering statement that must be filed with the SEC, provided to its intermediary, and made available to investors that, among other things, discloses:
- Information about officers, directors, and 20 percent owners
- A description of the company’s business and business plans, number of employees, and the use of proceeds from the offering
- Information about the risks of the offering
- The price to the public of the securities being offered, how the valuation of the securities was determined, the target offering amount, the deadline to reach the target amount, and whether the company will accept capital in excess of the target amount
- Information about related-party transactions
- Information about the financial condition of the company
- Financial statements that, depending on the target amount offered in crowdfunding transactions during the trailing 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant
- The duty to update the offering statement for material events over the course of the offering before completion, and to provide investors with the option to back out of their investment as a result
- Prohibitions on advertising crowdfunding offerings, other than very limited notices and communications through the intermediaries described below
- The requirement that crowdfunding transactions must take place exclusively online through platforms operated by an SEC-registered intermediary, either a broker-dealer or a new type of SEC registrant called a “funding portal,” which is required to:
- Have a reasonable basis for believing that the crowdfunding company is complying with applicable rules
- Ensure that the company’s disclosure is made publicly available for 21 days before securities are sold
- Provide investors with educational materials
- Take measures to reduce the risk of fraud and deny access to any company if it believes the company or the offering presents the potential for fraud or otherwise raises concerns regarding investor protection
- Make available information about the company and the offering
- Provide communication channels to permit discussions about offerings on the platform
- Avoid offering investment advice or making recommendations
In summary, the proposed rules will allow start-ups to raise up to $1 million annually through crowdfunding. At the same time, investors may only invest $2,000 or 5% of their annual income whichever is greater, if their income is in excess of $100,000. Previously start-ups were not able to sell company shares to interested investors through crowdfunding, but if these proposed rules are approved, that will all change.
Furthermore, companies will have to provide the SEC with documented information regarding officers, directors and owners who hold 20% or more of the company; as well as a business description, and a description of how the crowdfunding proceeds will be utilized. On the other hand, equity crowdfunding platforms, in order to be approved by the SEC, are required to provide all investors with education materials and take all possible measures to reduce the risk of fraud.
Companies like Deloitte expect crowdfunding to raise $3 billion globally this year alone, and will likely have a compound annual growth rate of 100%. This is because the new rules will allow ordinary investors to invest small amounts of capital, whereas only accredited investors were able to invest in crowdfunding previously. For this reason, the SEC’s goals are to keep this practice as safe as possible. SEC Chairman Mary Jo White said “We want this market to thrive, in a safe manner for investors.”
Matthew Andersen is the Web Editor for Juris Magazine and a 2L here at Duquesne Law. Mr. Andersen is currently a Junior Staff Member for the Duquesne Business Law Journal, and a member of the Duquesne Law Appellate Moot Court Board.
