Crowdfunding is increasingly becoming a viable alternative for businesses to raise money. If you are considering crowdfunding, be sure you know the requirements. I offer the following Q&A as talking points.
What is Crowdfunding? Crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people. The Securities and Exchange Commission (SEC) enacted regulations on January 29, 2016 that permits companies to offer and sell securities through crowdfunding.
How did this ruling affect crowdfunding? Prior to this date, a business that wanted to use crowdfunding as a means of raising money outside of more than one specific state, could only offer items like discounted tickets, discounted meals, tee shirts etc. to individuals and other businesses interested in participating in the crowdfunding offering. Until this date (January 29, 2016), a business desiring to use crowdfunding as a means of raising money, could not offer equity, debt, promissory notes, certificates of participation, or any other type of security to any individual or business in any more than one specific state, where that business was located, without incurring the expenses of a public offering of securities.
Why would I want to participate in crowdfunding? Crowdfunding to raise money for a project or venture has several advantages. One of these advantages is that a business is not limited to 35 unaccredited investors. (This is the case with a Rule 505, or Rule 506 private offering of securities).
How can I do a Crowdfunding Offering, and not be a Reporting Company? If a Company has any more than 500 shareholders/members as a result of the crowdfunding campaign, and $25,000,000 in assets, it will be a reporting company. A reporting company must file quarterly and annual reports with the SEC, which is prohibitively expensive.
How else is crowdfunding advantageous to a company? Crowdfunding can provide a business with more equity on the balance sheet. In most cases, Landlords and Lenders feel more confident about a business when it has more equity. Crowdfunding can also provide a business with more capital for expansion – for example, the business may want to hire more employees. Crowdfunding can also be used to expand in other ways – a company can raise more capital for production and distribution, for example. Another advantage to crowdfunding is this: If the crowdfunding offering is an equity offering, funds raised do not have to be repaid back to investors if things do not work out – except in the case of investor cancellation or when the company does not meet its fund raising target.
Are there other advantages? Crowdfunding offerings that are in compliance with the JOBS Act and its regulations, are exempt from state securities registration. They are not, however, exempt from state securities anti-fraud laws and regulations. It should be noted that very limited advertising for unaccredited investors is permitted – unlike other private offerings of securities. The contents of the advertisement are strictly regulated by the SEC, and can only include the following “tombstone advertisement” information:
- Name of broker dealer or the funding portal handling the offering.
- Terms of the offering.
- The company’s name, address, and web site.
What about costs? A company considering crowdfunding must be able to afford the legal and accounting costs. Many companies cannot. Crowdfunding is actually cheaper than doing a traditional securities public offering, and may not be much more expensive that a typical Regulation D exempt securities offering. The cost of doing a crowdfunding offering may also vary depending on a company’s corporate structure.
What are the rules for raising funds? If a company is raising money for a project or venture and is seeking investors that are located in more than one state, a business is limited to no more than $1,000,000 from a crowdfunding transaction during the 12-month period preceding the date of such offer or sale. Individual investors are also limited as to what they can invest. The total investment for an investor whose net worth is less than $100,000, cannot exceed either $2,000, or 5% of the investor’s income in all crowdfunding offerings during the 12-month period preceding the offering. If both the investor’s net worth and income are equal to or more than $100,000 during the 12-month period preceding the offering, that investor is limited to investing no more than 10% of either his or her income or net worth – whichever is less.
Can my investors resell any crowdfunded securities? Securities offered through a crowdfunding transaction may not be resold for 1 year. The following resales are permitted:
- Resales back to the Company
- Resales to an accredited investor
- Resales in a public offering of securities
- Or resales to a family member of the investor, to a trust controlled by the investor, or as a part of death or divorce.
Crowdfunded securities are not liquid. The investor cannot sell anytime she or he chooses.
What are the cancellation rights in regard to crowdfunded securities? Investors in a crowdfunded securities offering have cancellation rights, which is unlike most other types of securities offerings. Investors can cancel an investment commitment up to 48 hours prior to investment deadline.
How does a business conduct a crowdfunded offering? A business wishing to conduct a crowdfunding offering must first have its attorney file a Form C offering statement with the SEC prior to offering. Additionally, the Form C offering statement must be provided to all prospective investors prior to the offering.
What is the Form C offering Statement? The Form C offering statement contains numerous required disclosures; including but not limited to the following:
- The name of each person who owns 20% or more the Company’s voting securities;
- The Company’s business, and its business plan (note, traditional business plans are not what the SEC has in mind here);
- Risk factors, including all risk factors unique to the Company’s industry;
- The target offering amount, and the deadline to reach that amount;
- The use of the proceeds (this is a very detailed description of where the money is going);
- The process of cancelling an investment commitment;
- The price of the securities offered;
- The Company’s indebtedness;
- A description of all material transactions, which the Company is a party, with any director, officer, or 20% shareholder;
- And a description of the Company’s financial condition, including liquidity, capital resources, and results of operations (known as Management’s Discussion and Analysis).
What else is a company required to disclose? In addition to the list above, the Company is required to disclose all other “material information”, including information not specifically listed in Form C. For example, if the Company is engaged in the real estate business, the Company would probably have to disclose the condition of its properties, and past real estate history among numerous other factors. Also, if the Company is a limited liability company, a partnership, or an S-Corporation there must be a comprehensive discussion of the impact of federal and state income taxes on the investor’s investment in the Company.
Are financial statements required in a company’s filing? Yes, the Company is required to include one of the following financial statements in its form C filing:
- If the Company is raising $100,000 or less from investors, then the filing only needs to include tax returns certified by the Company’s CEO.
- If the Company is raising more than $100,000, but less than $500,000 unaudited financial statements reviewed by a CPA are required.
- If the Company is raising over $500,000 audited financial statements must be included.
Are there any other forms are needed for crowdfunding? During different stages of crowdfunding, the following forms are necessary:
- Once Form C has been accepted, if the business has any “material change” in its condition or operations, then the business’ attorney must also file Form CA with the SEC.
- When the business has first meet 50% of its fundraising target, then its attorney must file a Form CU progress update with the SEC.
- Every year, until the crowdfunding offering terminates, the Company’s attorney must file a Form CAR annual report with the SEC.
- The Company must also post financial statements on its website, as well as the current Management’s Discussion and Analysis of financial statements.
- When the offering terminates, then Form CTR termination of reporting must be filed with the SEC.
How is the offering conducted? The Company had some options, as follows:
- The company must use either an SEC and self- regulatory organization registered broker or dealer, or
- The company must use an SEC and self-regulatory registered funding portal.
In either case above, the company must compensate them to conduct the offering. Any funding portal or broker/dealer are required to:
- Conduct background checks on the Company, including checking for securities regulatory enforcement actions on each officer, director, and 20% shareholder of the Company;
- Provide the offering statement prepared by the Company to each prospective investor; and
- Provide a questionnaire to each prospective investor, ensuring that the prospective investor understands the risk of loss of the entire investment, and understands that the crowdfunding investment is illiquid.
Crowdfunding offers a business many advantages when it comes to raising funds. The business, in turn, must be confident that it can navigate the legal minefield as summarized above.