New SEC Crowdfunding Proposal: One Small Step for Regulators, One Giant Step for Startups?

“Under the JOBS Act, the SEC was to propose equity crowdfunding rules by Dec. 31, 2012.” (Brian Korn of Pepper Hamilton)

Did the Securities and Exchange Commission just break the crowdfunding logjam?

On October 23, SEC commissioners unanimously agreed to propose a framework that will allow entrepreneurs and startups to raise capital via social media and the Internet.

The SEC’s proposal is more than a year late, writes attorney Brian Korn of Pepper Hamilton. But more importantly, because the rules are “a virtual reprint of the parameters” set forth in the Jumpstart Our Business Startups (JOBS) Act, they won’t be particularly helpful to startups. Korn continues:

“The proposed rules are extremely impractical because of the restrictions and procedural hurdles a crowdfunding issuer, investor and funding portal will have to endure to raise capital. Compared to other forms of crowdfunding and capital raising, equity crowdfunding to the public has the worst ‘bang for your buck’ in all of corporate finance. […]

The high expenses compared to the low maximum amounts that can be raised by a company and invested by an individual make public equity crowdfunding one of the costliest forms of (legal) capital raising.”

For your reference, here’s a look at key provisions in the SEC’s crowdfunding proposal:

  • All transactions must pass through approved intermediaries:

“Crowdfunding transactions must be conducted through an SEC-registered intermediary on an Internet website or other similar electronic medium to help ensure that the offering is accessible to the public and that members of the crowd can share information and opinions.  The intermediary can be a broker-dealer or a new type of SEC registrant, a so-called funding portal. The offering must be conducted exclusively online by the broker-dealer or portal.” (Bettina Eckerle of Eckerle Law)

  • Not all companies are eligible to crowdfund:

“Certain companies will not be eligible to avail themselves of the crowdfunding exemption, including foreign issuers, SEC-reporting companies, companies that are registered under the Investment Company, issuers with no specific business plan, SPACs or blind pools, or issuers that are delinquent in their SEC filings.” (Anna Pinedo at Morrison & Foerster)

  • Investments are limited based on investor net worth:

“Crowdfunding caps the amount a person can invest in all crowdfundings over a 12-month period at 10 percent of annual income or net worth (incomes of $100,000 or more) or the greater of $2,000 or 5 percent of annual income or net worth (incomes of less than $100,000).” (Korn)

  • Companies must regularly report on financial performance and other key business information:

“Investors must receive adequate information regarding the offer at various points in time through various electronic means, such as through filings with SEC and disclosures provided on the intermediary’s platform.  The offering documents must contain financial statements that, depending on the amount sold in a 12-month period, must be accompanied by a company’s tax return or reviewed or audited by an independent public accountant or auditor.” (Eckerle)

  • Funding portals must educate and inform investors, and will be strictly regulated:

“Funding portals will be required to undertake certain activities, such as providing investors with educational materials about the risks of crowdfunding; making available information about the issuer on its website; and complying with AML and privacy requirements.  The proposed rules incorporate requirements designed to prevent or mitigate conflicts of interest.  The proposed rules require regulatory checks on officers, directors, major shareholders of portals.” (Pinedo)

  • Advertising outside of crowdfunding portals is forbidden:

“Unlike Regulation D Rule 506 private placements to accredited investors following the JOBS Act, crowdfunding does not allow advertising except solely to direct investors to the appropriate broker/funding portal.” (Korn)

  • Issuers must prepare US GAAP-compliant financial statements:

“An issuer also will be required to prepare financial statements compliant with US GAAP for a period that is the shorter of the two most recently completed fiscal years or since the issuer’s inception.  […] For example, for smaller offerings, the financial statements must be certified by the issuer’s chief financial officer; whereas for larger offerings, the financial statements must be audited.” (Pinedo)

  • Companies can only raise $1 million per year:

“Crowdfunding caps an amount an issuer can raise to $1 million in any 12-month period.” (Korn)

  • Investors must hold shares for at least one year:

“Securities purchased in a crowdfunding offering cannot be resold for one year.” (Eckerle)

The updates:

Related reading:

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