Investors around the U.S. rejoiced late in 2015 as startups and entrepreneurs were no longer limited to seeking funds from accredited investors alone. With regards to Title III of the JOBS Act, the SEC’s Regulation Crowdfunding had an accompanying 686 page document that explained these new rules.
For those of you who didn’t have time to read and analyze these new Title III crowdfunding rules, here’s a breakdown of the final regulations from the SEC.
What is Title III Crowdfunding?
Before the passing of Title III of the JOBS Act, only accredited investors could participate in equity crowdfunding. Meaning that everyday citizens weren’t left with many options if they wanted to invest in a startup of their choice.
The change could not have come at a better time as crowdfunding is on track to surpass VC funding in 2016.
As a new exmeption 4(a)(6) of the Securities Act of 1933, investment crowdfunding in this case refers to the use of an online intermediary which includes many reputable crowdfunding platforms.
Broken down even further, Title III crowdfunding defines parties involved as issuers, investors, and intermediaries:
So for issuers, or the startups and entrepreneurs raising these funds, what are some things to keep in mind?
- Limited to raising $1M in a rolling 12-month period
- Will not be integrated with other offerings
- Must use one online intermediary
- Must be US entity
- Cannot be Investment Company or company relying on an exemption from the ‘40 Act
- Cannot use SPV structure
- Must have a business plan
- Cannot intend to merge with an unidentified company
- Cannot be public reporting company
- If conducted an offering pursuant to Regulation CF in the past must be compliant with ongoing reporting requirements
- Cannot be a Bad Actor
- 12(g) caps don’t apply as long as issuer is compliant with Regulation CF, does not have more than $25M net assets and has engaged a transfer agent
Issuers – Disclosure Requirements (Form C)
Although the doors have been opened to a wider pool of investors, issuers still need to have the right disclosures prepared when filing with the SEC. As part of Form C, issuers will need to make the following information is documented:
- Name, legal status, address, website
- Directors, officers, background, offices held
- Identity of 20% beneficial holders of voting securities
- Description of the business
- Financial condition
- Target offering amount, maximum amount, deadline
- Description of the securities including prices and how determined
- Use of proceeds
- Risk factors
- Ownership, capitalization, indebtedness
- Offering mechanics
- Related party transactions
Issuers – Disclosure Requirements – Financial Information
In addition to Form C, financial information needed will depend on the size of the intended investment needs:
- Up to $100,000:
- Information from tax return filed for the most recently completed fiscal year
- GAAP financials for past two years or time in existence certified by CEO
- Over $100,000 up to $500,000:
- GAAP financials for past two years or time in existence certified by CEO and reviewed by public accounting firm
- Over $500,000 up to $1,000,000:
- GAAP financials for past two years or time in existence certified by CEO and audited by public accounting firm
- One time exemption for first time crowdfunding companies can provide reviewed financial statements rather than audited
Additionally it’s worth noting that formal consent from an accountant/auditor is not required.
Issuers – Disclosure Requirements – Ongoing Reporting
Providing progress reports on the offering are not only a good idea for building trust with investors but they’re also a very much required part of the disclosure requirements.
Issuers can rest easy as they-can rely on intermediaries to provide progress reports to investors. However at the close of the offering, Form C-U must be filed.
On an annual basis, Form C-AR must also be filed. Form C can be used as the base and simply update the disclosure and delete information about the offering. This does not require audited or reviewed financial statements.
Form C-AR must be filed continually until one of the following occurs:
- Issuer becomes public filer
- Issuer has filed at least one Form C-AR and has fewer than 300 holders of record
- Issuer has filed at least three Forms C-AR and has assets of $10M or less
- All Reg CF securities are purchased, repurchased or redeemed
- Issuer liquidates or dissolves
Issuers – Advertising Limitations
Sure, there is absolutely nothing wrong with promoting your offering, but you will have to contend with some limitations with these efforts.
- Statement that offering is being conducted, name of and link to intermediary
- Terms of the offering
- Factual information about the issuer including a brief description of the business
- Similar to tombstone ads under Rule 134
- Medium agnostic
- Can pay for advertising but cannot be transaction based or receive PII
And a big consideration with advertising that you should always think about even outside of your offering is disclosing relationships with promoters. Although perhaps more an issue with the FTC, you must make sure that it is apparent to the average citizen when you and a promoter have an agreement to promote your offering.
With a much wider pool of investors, individuals face no accreditation restrictions. Issuers and intermediaries can rely on investor attestations of net worth, annual income and annual investment amounts.
However, there are some limitations:
- If net worth or annual income is less than $100,000, can invest the greater of $2,000 or 5% of such net worth or income annually
- If net worth and annual income is $100,000 or greater, can invest 10% of net worth or annual income (whichever is lesser) up $100,000 annually
- Can combine with spouse
- Resales – restricted for one year except:
- To the issuer
- To an accredited investor
- As part of a registered offering
- To a member of the family in connection with death, divorce or similar
For intermediaries, here are a couple items in accordance with Title III
- Must be registered broker-dealer or crowdfunding platform
- Must register with FINRA
- Must provide communication channel between investors and issuer and amongst investors
- Must provide educational materials for potential investors
- Must get affirmative acknowledgements that issuers understand risks
- May curate prospective issuers
- Must have a reasonable basis to believe that an issuer is compliant with Reg CF
- May receive cash and/or equity compensation from issuers for services provided
- Must provide notices to investors
- Must give investors right to cancel transaction up to 48 hours prior to the offering deadline
- Can compensate third parties for advertising as long as they do not receive any PII and
- “Issuer” liability based on facts and circumstances
- Broker-dealers and funding portals can fee split
Intermediaries – Funding Portals
With regards to funding portals:
- Register with SEC and FINRA
- Cannot custody funds
- Must engage qualified third-party to custody funds and conduct transaction
- Cannot provide investment advice – recommend one issuer over another
- Can provide objective search criteria and highlights of issuers
- Can advise issuers on deal structure and documentation
- May be foreign entity
- No fidelity bond, AML, KYC or BSA requirements
- Must adhere to same privacy rules as broker-dealers
Final Thoughts & Practical Considerations
Wading through the new Title III crowdfunding rules may seem overwhelming, but hopefully our breakdown helps it all seem a little less daunting.
Additionally, here are a few questions and considerations:
- Who will use this exemption, if anyone?
- Will Reg CF issuers be able to get future financing?
- Can concurrent offerings be conducted?
- What are the legal costs?
- What are the accounting costs?
- Is it practical to be a funding portal?
- How much volume is possible?
- Who will invest in these deals?
- What about fraud? Failure?
In the coming months, you’ll learn more about how iDisclose software can help issuers, investors, and intermediaries with all the required forms to be filed.
Download this presentation – iDisclose Title III Final Rules PP