Editorial · May 25, 2016
Equity Crowdfunding Rules: What Regulation CF Allows
Equity crowdfunding rules from the Securities and Exchange Commission (SEC) took effect on May 16, 2016. They let an eligible U.S. company sell shares, debt or other securities to the public online. The company can raise up to $1,000,000 this way in 12 months. The sale has to run only on the online platform of an intermediary. An intermediary is a registered broker-dealer or funding portal. The SEC's name for the rule is Regulation Crowdfunding, shortened here to Regulation CF.
How the rules came about
Congress opened the door with the JOBS Act, enacted on April 5, 2012. Title III of that law created a federal exemption so companies could offer and sell securities through crowdfunding. The SEC adopted its final rules on October 30, 2015. Most of them took effect on May 16, 2016. The rule and forms for funding portal registration took effect earlier, on January 29, 2016.
The SEC says crowdfunding had generally not been used to sell securities. That is because offering a share of a business's returns or profits could trigger the federal securities laws. An offer or sale of securities must be registered unless an exemption applies.
Who can raise money
A company must be organized under the laws of a U.S. state or territory or the District of Columbia. The rules also shut out these companies:
- companies that must file reports with the SEC under the Securities Exchange Act of 1934
- investment companies, and companies the Investment Company Act excludes from that term
- companies with no specific business plan, or whose plan is to merge with or buy an unidentified company
- companies with a disqualifying history, such as certain convictions or orders against an officer, director or owner of 20 percent or more of the voting power
- companies that used the exemption before and still owe an annual report due in the two years before the new offering statement
The $1 million cap and investor limits
A company can sell no more than $1,000,000 under Regulation CF. The count covers the 12 months before a sale, plus the new offering. Crowdfunding sales by its predecessors are added in. So are such sales by entities it controls, or that share a controlling party with it. Money raised by other means, such as other exempt offerings, does not count toward the cap. Some who commented on the proposal asked the SEC to measure the cap after platform fees. The SEC declined, so the cap covers the full amount sold.
Investors have limits too. Anyone can invest. But in any 12-month period, an investor's total across all crowdfunding offerings is capped. The cap depends on annual income and net worth:
- If either is under $100,000, the cap is the greater of $2,000 or 5 percent of the lesser of the two.
- If both are $100,000 or more, the cap is 10 percent of the lesser, up to $100,000.
What a company must file and share
Before the offering starts, the company files Form C with the SEC. It also gives the form to investors and its intermediary. Among other things, the form covers:
- the business and its officers and directors
- how the money will be used
- the price, or how it will be set
- the risks
- the target amount and deadline
Which financial statements the form needs depends on the target amount, or the maximum if the company will accept more. Sales under the exemption in the past 12 months are added to that amount. The minimums are:
- $100,000 or less: statements and any tax return figures certified by the principal executive officer.
- More than $100,000, up to $500,000: statements reviewed by an independent accountant.
- More than $500,000: audited statements. A first-time user can give reviewed statements for a target up to $1,000,000.
A company that already has more fully checked statements must provide those instead.
A company, or anyone acting for it, cannot advertise the terms of its offering away from the platform. The exception is a limited notice that says a crowdfunding offering is under way and points to the platform. It may add only:
- the terms
- the intermediary's name
- the company's name, address, phone, website, email and a short business description
After a sale, the company must file an annual report with the SEC and post it on its website. The report is due within 120 days after the fiscal year ends. That duty ends only in cases the rule sets.
How funding portals fit in
A company may not use more than one intermediary for an offering. That includes crowdfunding offerings that run at the same time.
The JOBS Act created the funding portal, a new kind of intermediary. It can help sell securities online without registering as a broker. A portal registers with the SEC on Form Funding Portal. It must also join a registered national securities association. The Financial Industry Regulatory Authority (FINRA) is currently the only one. Among other things, a portal cannot:
- give investment advice or recommendations
- solicit purchases, sales or offers to buy the securities on its platform
- pay anyone for that soliciting or based on sales, with limited exceptions
- hold or handle investor funds or securities
A portal must direct investors to send their payment to a qualified third party, such as a bank. That party holds the funds. The funds go to the company only if commitments from all investors meet the target. The cancellation period must also have ended. Investors can cancel for any reason until 48 hours before the deadline. The offering details must be public on the platform for at least 21 days before any sale.
Portals and broker-dealers also need a reasonable basis to believe a company follows the rules. They must run background checks on the company and its officers, directors and owners of 20 percent or more of the voting power. The checks look for disqualifications. Intermediaries must also give investors educational materials and a discussion channel that the public can read.
The SEC staff's guide for intermediaries says only the rule itself gives complete and definitive information. So read 17 CFR 227.100 and the sections after it before you plan a raise.