By: Eric H. Milliken, Sutter Law, San Francisco Business Attorney
Table of Contents
- What is Crowdfunding?
- What has changed?
- What are the limitations of “Intermediaries”?
- Funding portals are prohibited from:
- What information do you need?
- Compliance Requirements:
- Liability Issues:
- Issuers are prohibited from:
- Crowdfunded securities are:
- Rule 506 General Solicitation:
- The value of your primary residence
- Rule 506
What is Crowdfunding?
You may know…sites like Kickstarter, Rockhub and Indiegogo.
These and other websites take small donations for charitable, artistic endeavors or contributions to launch a business in return for the product being made, service, or some type of a thank-you gift.
What has changed?
The JOBS Act creates a special exemption for crowdfunding so that companies can sell securities by way of crowdfunding. Generally, under the Act, companies are limited to raising $1 million in any 12-month period using crowdfunding and $2 million with audited financials.
Companies cannot crowdfund on their own but will have to engage an intermediary that’s registered with the SEC as a broker or funding portal. These intermediaries will be required to vet the company seeking funding.
Individual investors will be limited in the amount they can invest by way of crowdfunding in any 12-month period to:
if your annual income or net worth is less than $100,000 – greater than $2,000 or 5 percent of annual income or net worth, or if your annual income or net worth is more than $100,000 – 10 percent of annual income or net worth up to a maximum of $100,000.
When calculating net worth, you should not count the value of your primary residence or any loans secured by the residence (up to the value of the residence).
What are the limitations of “Intermediaries”?
Intermediaries may not compensate promoters or finders and may not allow their officers or directors to take a financial interest in any issuer using their services.
Funding portals are prohibited from:
- Offering investment advice,
- Soliciting transactions for securities offered on the portal, or compensating employees or agents for doing so, and
- Holding investor funds or securities.
What information do you need?
Issuers must provide the following information to the SEC in its initial filing and make the information available to its intermediary, potential investors, and investors:
- The name, legal status, and addresses of the business, and names of directors, officers, and significant shareholders,
- A business plan and description of the business,
- Financial information that may, depending on the size of the business, include income tax returns and officer-certified financial statements, unaudited financial statements or audited financial statements,
- A description of the purpose and intended use of the funds, the target offering amount, and the price of the securities,
- The ownership and capital structure of the business, including the terms of each class of the issuer’s securities, risks of minority ownership and methods of valuation for the securities, and
- Any other information required by the SEC.
Compliance Requirements:
Issuers must provide the SEC and investors, through the crowdfunding intermediary, with annual reports on the results of the company’s operations and financial statements for the prior year.
Liability Issues:
An issuer, including its officers, directors or partners, can be liable for any material misstatements or omissions.
Issuers are prohibited from:
Advertising the securities, except for providing a notice that directs investors to the intermediary.
- Compensating any promoter of the securities, unless such compensation is fully disclosed.
Crowdfunded securities are:
Considered “covered securities” exempt from state securities laws, regulations and fees.
- Restricted securities, subject to a one-year holding period, except when transferred under certain limited circumstances.
Rule 506 General Solicitation:
A frequently used exemption is what’s called a Rule 506 exemption. Many startups, such as those in Silicon Valley and San Francisco, use this exemption to raise money from investors, like venture capital firms.
The two principal limitations for using the exemption are that the offering be principally limited to accredited investors and that there is no general solicitation.
First, the restriction on general solicitation means that the company can’t advertise the offering, such as on TV or in a print publication.
Otherwise, this would be a public offering and registration would be required. The other limitation is that it mostly be for accredited investors.
The exemption does allow for a limited number of non-accredited investors.
From the standpoint of individual investors, accredited investors in short are high income or net worth individuals. The premise for the exemption is that these investors are capable of fending for themselves—
An accredited investor, in the context of an individual investor, is a person: who has a net worth over $1 million, either alone or together with a spouse, or whose income exceeds $200,000 (or $300,000 together with a spouse) in the prior two years, and reasonably expects the same for the current year.
The value of your primary residence
When calculating you should not count the value of your primary residence or any loans secured by the residence (up to the value of the residence).
This exclusion of a primary residence was a change made by the Dodd-Frank Act. Otherwise, the definition hasn’t changed since it was conceived in 1982. $200,000 in income is still a lot today but was more some 30 years ago. Under Dodd-Frank, the SEC can revisit the definition every four years and make changes.
These limitations, for all practical purposes, limited the pool of investors in any particular company’s exempt offering.
Rule 506
Now, under the JOBS Act, companies can conduct general solicitation and advertising for a Rule 506 offering. This means that you may see a TV or newspaper advertisement to buy the common or preferred stock of a private company. You may also see a proliferation of websites that, similar to crowdfunding, offer a platform for companies to raise money with a Rule 506 offering online.
However, only accredited investors may participate in these offerings that take advantage of general solicitation. This is unlike the existing exemption which allows for up to 35 non-accredited investors. If you are an accredited investor and find yourself interested in investing in a private company, you should bear in mind the reasons that such offerings are limited from the public. These offerings are not for everyone and carry a very high degree of risk. For every successful venture, there are numerous failed ventures.
You will not be seeing such advertising immediately as this area is again contingent on SEC rule-making. The SEC has not fully implemented Title III of the Jobs Act as of yet, but we should see the implementation by January 2016.
If you have any questions about Title II or Title III please feel free to contact Sutter Law, a San Francisco Business Law Firm.
