Armanino Blog

Online Crowdfunding for Small Investors

by Jason Gilbert
January 20, 2016

On October 30, the Securities and Exchange Commission (SEC) approved its final crowdfunding rules under the 2012 Jumpstart Our Business Startups (JOBS) Act, opening the doors for start-ups to raise equity online from smaller “nonaccredited” investors. Here are the details of the long-awaited rules, which contain several changes to the proposal that was issued more than two years ago.

Crowdfunding debate
Historically, the SEC has allowed private companies to solicit capital only from “accredited” investors, which are people with net worth of at least $1 million (excluding the value of their primary residences) or annual income of more than $200,000 per individual (or $300,000 for married couples). Moreover, online solicitations to these wealthy individuals were required to come from SEC-registered intermediaries.

On October 30, in a 3-1 vote, the SEC approved final crowdfunding rules that establish a registration exemption for companies raising up to $1 million a year through online funding portals. They also create a registration process for intermediaries and add a new incentive for them by allowing intermediaries to take ownership stakes in the issuers as compensation. Investors don’t need to be accredited to participate in these offerings.

More than two years in the making, the crowdfunding decision was among the most divisive of the regulatory mandates from the JOBS Act. The SEC debated how to shield unsophisticated investors from fraud while keeping the rules viable for start-up companies with limited resources.

Proposed vs. final rules
Under both the proposed and final rules, companies must comply with disclosure and accounting requirements that scale upward with the size of the offering. But the final rules contain several major changes.

For example, under the 2013 version of the crowdfunding proposal, a company raising less than $100,000 would have been required to provide investors with prior-year tax returns and a financial statement certified by the CEO. A company raising between $100,000 and $500,000 would have been required to use an independent public accountant to review the financial statements. A company raising more than $500,000 would have been required to provide investors with audited financial statements — a requirement that critics said was unworkable for many start-ups.

Under the final rules, a start-up using the crowdfunding exemption for the first time and seeking to raise more than $500,000 will need to have an accountant prepare only reviewed financial statements. Subsequent offerings above $500,000 will require audited financials.

Additional details
The final crowdfunding rules also limit how much investors can purchase in an offering. Investors earning less than $100,000 can invest the higher amount of: 1) $2,000 per year, or 2) 5% of the lesser of their net worth or income. Investors with both income and net worth above $100,000 can invest 10% of their income or net worth, whichever is less. Additionally, no one will be allowed to put more than $100,000 into crowdfunding deals in any one year.

The SEC will also require a one-year holding period before reselling securities purchased through a crowdfunding deal. And crowdfunding intermediaries, who can be either broker-dealers or newly registered funding portals, will be required to join the Financial Industry Regulatory Authority (FINRA).

Coming soon
The rules are scheduled to become effective six months after they are published in the Federal Register, which usually happens a few weeks after the SEC posts a rule to its website. Funding portals, which will be used to sell securities to investors, have until January 29, 2016, to register with the SEC.

Over the next three years, the SEC will study the effect of the rules on the market. SEC Commissioner Kara Stein, who voted in favor of the final rules, says this study will allow the SEC to respond to changes “if we have gone too far in one direction or the other.”

A closer look at intrastate crowdfunding
Also in a 3-1 vote on October 30, the SEC agreed to issue a proposal relaxing the rules regarding so-called “intrastate” crowdfunding. These offerings allow a company to raise typically small-dollar equity investments from large numbers of backers within a single state, without requiring the investors to be accredited.

An increasing number of states are adopting intrastate investment laws. The SEC’s proposal would lift in-state restrictions on marketing those deals, relax some eligibility requirements and raise the investment limit to $5 million per year from investors across multiple states, without an accreditation requirement.

January 20, 2016

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