Summary: The Securities and Exchange Commission released proposed Regulation Crowdfunding, the long-awaited JOBS Act rules designed to help small companies raise capital from the general public. The proposed regulations promise to change the landscape for small companies in raising capital. This shift will impact the risk assessment for investors, corporate executives, and Board members.
Crowdfunding: Waiting and Watching for Regulation
On October 23, 2013, the Securities and Exchange Commission released proposed Regulation Crowdfunding, the long-awaited JOBS Act rules designed to help small companies raise capital from the general public.
Over the next few weeks, the public will be able to submit comments on proposed Regulation Crowdfunding. Based on the activity on the SEC website to date, we anticipate a large number of comments that the SEC will then take under consideration. The SEC may then issue final regulations, modify and re-propose the regulations, or let the proposed regulations die without further action. The last option is highly unlikely given that the JOBS Act requires the issuance of crowdfunding regulations.
The Long and Short of Proposed Regulation Crowdfunding
Proposed Regulation Crowdfunding attempts to provide easier ways for small businesses to raise capital while honoring the SEC’s mission of protecting investors. Walking this fine line creates highlights and lowlights for small businesses, investors and their advisors. A significant feature of proposed Regulation Crowdfunding is its very late issuance – almost a year past the deadline required by the JOBS Act – but still a welcome first step toward expanding access to capital. It’s also 589 pages long, which makes a thorough review beyond the patience of many small business owners or investors.
We do have that kind of patience - so, based on an initial review and public comments received to date, here are highlights and lowlights of five key elements of proposed Regulation Crowdfunding.
1. Fundraising Limit of $1 Million in a 12-Month Period
- Highlight: The $1 million limit only applies to funds raised under new Section 4(a)(6) of the Securities Act of 1933 for crowdfunding and not to other exemptions available to small businesses.
- Lowlight: Most commenters to date believe the limit is too low and ignores that different companies may require more capital to grow and maintain that growth.
2. Required Use of an Intermediary: Broker or Funding Portal
- Highlight: Restricting a company to using only one intermediary for crowdfunding should improve oversight and compliance and reduce the likelihood of confusing investors with duplicate offerings.
- Lowlight: The proposed rules add a new layer of bureaucracy for funding portals, including registration with FINRA, and require significant oversight responsibilities which may turn inspire significant funding portal fees.
3. Company Disclosure and Reporting Requirements
- Highlight: Prospective investors will benefit from the thorough disclosure and ongoing reporting requirements provided in proposed Regulation Crowdfunding. These include financial statements, a description of the company’s business plan, the intended use of proceeds, and updates during the crowdfunding process and after fundraising has concluded.
- Lowlight: The disclosure and reporting requirements appear to be modeled on those for more substantial companies. This could make crowdfunding too difficult and expensive for most small companies, who may not be “ready for prime time” when faced with disclosure and reporting burdens far beyond their capabilities and tolerance.
4. Consequences of Failure to Meet Deadlines and Investor Cancellation Provisions
- Highlight: Companies will be required to select a target offering amount, to disclose whether they will accept investments in excess of that, and to set a specific deadline for completion of the offering. These measures will improve clarity for prospective investors.
- Lowlight: Investors will have an unconditional right to cancel their investment commitments until 48 hours prior to the offering deadline. This may provide a remedy for “investor’s remorse” but could create last minute havoc for companies. Also, a company that does not raise the targeted amount by the deadline would have to return all funds to investors and still pay any intermediary fees and costs.
5. The SEC Belief in the “Wisdom of the Crowd”
- Highlight: The contents of proposed Regulation Crowdfunding are based on the SEC’s stated belief in the “wisdom of the crowd” and are consistent with recent SEC initiatives, such as permitting the use of Twitter and other social media to disseminate public company information.
- Lowlight: There is no evidence that this collective wisdom has prevented or reduced investor fraud. Both unsophisticated and experienced investors have been defrauded in a wide variety of capital-raising transactions. Further, a “crowd” of unsophisticated investors can create problems for company management and scare away the larger and more sophisticated investors required for later growth stages.
Future Crowdfunding
Proposed Regulation Crowdfunding is poised to change the way companies of all sizes raise capital. The proposal could also lead to changes in the way the SEC deals with disclosure requirements by incorporating more use of social media and by shifting more of management duties to intermediaries. Stay tuned for updates.