What to expect from JOBS Act Title III Investment Crowdfunding
Crowdfunding Regulations Summary
This is a quick overview of key points in the SEC’s proposed rules on Crowdfunding (http://www.sec.gov/rules/proposed/2013/33-9470.pdf).
Overview:
Companies will be able to “crowdfund” up to $1M in any 12-month period from unaccredited investors using one intermediary – either an Internet Funding Platform (registered with FINRA) or a Broker/Dealer with an Internet site. They can raise money at the same time using other means (e.g., AngelList) under existing accredited investor rules.
Any investor can invest from $2K to $100K in a 12-month period. The 12-month investment limit is based on the greater of annual income or assets – 5% of that amount if less than $100K (but never less than $2K), 10% if greater than $100K (but never more than $100K). The investors will self-certify to their income, assets, and other investments (intermediaries must also use evidence they have of activity).
Disclosures (must also be filed electronically with the SEC):
- Resumes of company principals for the last 3 years, including whether they’re currently working elsewhere
- How much is the minimum to close the round, maximum that will be accepted (and what will happen if maximum is exceeded), and date of close.
- Number of employees
- Business plan (quick paragraphs or slide decks are OK for early stage)
- Income tax return of the company for most recent year (if any)
- US GAAP financials & CEO discussion of the company financial condition
- <$100K raised, can be sworn to by the CEO
- $100K-$500K must be certified by a CPA
- >$500K must be audited
- High level cap table, including terms of any other class of security
- Detailed use of proceeds (if there are multiple options, discuss how management will choose between them, etc.)
- Full discussion of risks, including risks associated with other classes of stock, dilutive issuances, etc.
- Every 5 days, notify the SEC electronically of any progress towards raise
Ongoing Responsibilities of the Company:
- Update investors and the SEC (electronically) with financials (to the same standard as that required for the raise) and company status every year until acquisition, public, or go out of business
- Must maintain the ownership records (ownership transfers, addresses, etc.) – can outsource this to another service.
- Can’t be an investment company (i.e., no funds, special purpose vehicles, etc.)
Offering:
- Both unaccredited and accredited investors can participate, but are subject to the same rules. Alternatively, companies can raise a separate accredited investor round at the same time (the regular way).
- Can discuss publicly, but only to admit that the fundraising exists and point people at the platform
- Anybody compensated by the company in any way (interpreted broadly) must disclose that when talking about the company (which they can only do on the platform if it’s related to fundraising)
- Price of the security can be left blank as long as method for pricing is disclosed (e.g., auctions allowed)
- Must be up for at least 21 days before close
- Investors may cancel an investment anytime up to 48 hours prior to close
- Can be resold to accredited investors (but not to other unaccrediteds)
- Doesn’t count towards the 2,000 shareholder limit (even if resold)
- Everybody must pass bad-actor checks by the intermediary, including anybody with more than 20% ownership
- On costs, SEC estimates about $10,000 in costs for the company doing the crowdfunding (legal, form preparation, ec.) plus about $15,000 per year (including the first year) for companies with CPAs/auditors reviewing the financials (>$100K raised).
- The SEC estimates that funding portals will charge roughly 10% of the raised amount on top of those expenses.
- The SEC doesn’t include the bad actor checks costs in that, which are also required (and must be verified by the intermediary) – from the bad actor regs, though, they estimate another $1,200 plus 11 hours of time from the company (call it ~$2,500 overall).
Intermediary (Funding Portal or Broker):
- Register with FINRA as either a Broker Dealer or Funding Portal (using a “form Funding Portal” which is similar to the full Broker-Dealer registration). However, they leave open that the industry could self-organize another entity to handle registration for Funding Portals.
- Verify that the company has a way to accurately track cap table (owner addresses, transfers, etc.)
- Educate investors, and run them through a questionnaire proving they’ve been educated – pretty broad, including all risks
- Disclose how much they are compensated on each deal
- File issuer materials with the SEC
- Expect occasional visits from the SEC or FINRA to inspect premises, operations, platforms, and records
- Keep records of everything
- Intermediaries are considered issuers for the purposes of liability (errors, omissions, or fraud on the part of the issuer)
- SEC estimates $770K to set up a broker and $270K a year to maintain that status. SEC estimates $417K to set up a funding portal and $90K a year thereafter. (Note: this sounds pretty low to me given liability and other issues – they’d need E&O / D&O insurance in those estimates and probably more development costs than they include)
Funding Portal-Specific:
- Must accept any company onto the platform that fits pre-set objective criteria (e.g., “companies in San Francisco” or “Restaurants”) and isn’t suspected of fraud. Cannot use subjective assessments of companies to decide who to take (the SEC considers this “investment advice or recommendation” which is banned by the JOBS Act).
- Cannot take an equity stake in the company. This includes taking equity for the crowdfunding services – must take only cash. This includes any director or officer of the company (i.e., can’t invest on their own platform).
- Can’t touch the money as a funding portal (must have a bank or other escrow-like agent sit between the investor and the company).
- Funding portals appear to be able to take transaction-based compensation without having to register as broker-dealers.
- Cannot pay anybody for lists of investors (shall not “compensate promoters, finders, or lead generators for providing…personally identifying information of any potential investor”). Can advertise.
- Advertising the platform, providing search functions, advising issuers, paying for customer referrals (but not lead lists), highlighting and displaying offerings, and limiting offerings objectively or based on fraud can all be done without running afoul of other laws (general solicitation, etc.)
- Must have a “Fidelity Bond” of $100K (insurance against dishonest acts by employees)
- Can highlight (top of sort, feature, etc.) offerings by objective criteria only (how close they are to close, momentum, etc.) but not subjective criteria (any opinion about the deal). These criteria must be published and explained clearly in advance. Unclear whether an outsider’s subjective criteria can be used as one of your objective criteria (e.g., crowd ratings?)
- Must provide ways for the investors to communicate with each other and with the company – in public. Only registered members can comment, but the comments and responses must be available publicly (not behind login). The portal cannot moderate or comment itself other than enforcing rules. Unclear what to do about spam.
- Can advise issuers on terms and presentation materials (form, not content)
Source: Kevin Laws (klaws@angel.co) at AngelList
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