On October 26, 2015, the Securities Exchange Commission (SEC) announced that it will consider whether to adopt rules and forms under Title III of the Jumpstart Our Business Startups (JOBS) Act, what has become known as the “Crowdfund Act.”
Three years ago, President Obama signed into law the JOBS Act, which is comprised of seven titles. Titles III and IV generated the most attention because they are at the heart of what businesses can and cannot do to raise capital, but their implementation rests on the SEC adopting final rules. On March 25, 2015, the SEC approved and released the final rules for Title IV, which has become known as Regulation A+. Under this regulation, start-ups have the opportunity to “test the waters” to see if investors are interested in their company, and if so, can raise up to $50 million by selling to the general public. Regulation A+, however, has generally been characterized as a vehicle for “super-startups,” which are companies between seed stage and an IPO. While the announcement of the SEC’s final Reg A+ rules made a big splash, the start-up world, especially companies who have not reached larger funding stages, have been waiting for the final rules for Title III, the “Crowdfund Act.”
The purpose of the Crowdfund Act is to create an additional exemption from a traditional registered offering that mandates SEC filings, audits, and other compliance requirements. For startups, these requirements are, quite simply, an expensive head-ache, although some commentators caution that even under the new rules, raising money will cost a pretty penny. See Venture Beat. Nevertheless, the new rules are supposed to do three things: 1) reduce the burden on start-ups, especially when they are only in beginning stages, seeking smaller capital contributions and operating on a shoe-string budget; 2) open more opportunities for start-ups to utilize online media to reach investors, something that is presently restricted by securities laws under the current exemptions; and 3) permit start-ups to reach a greater spectrum of investors because they will not be limited to seeking accredited investors.
If you are unfamiliar with Title III, you may be wondering why the Crowdfund Act is necessary because there are already a number of equity crowdfunding sites that exist, such as CircleUp, Onevest and SeedInvest. These types of equity crowdfunding sites generally cater to companies raising funds under Exchange Act 506 of Regulation D. Title II of the JOBS Act established that companies may use general solicitations to reach investors, but they must be accredited investors. As a result, most current equity crowdfunding sites are limited to investing opportunities for accredited investors, which the SEC defines as an individual with a net worth of at least $1 million (this calculation does not include the value of an investor’s primary residence) or have an annual income of at least $200,000 ($300,000 jointly for a married couple) and have an expectation to make that amount in the year of his/her investment.
Additionally, more than 20 states have established their own intrastate equity crowdfunding rules, permitting unaccredited investors to contribute to local projects. For example, in February of this year, D.C. welcomed its first successful equity crowdfunding campaign to establish, “Prequel,” a local dining venue. NextSeed also closed its first funding offer for a small Texas business, Hair Revolution, thanks to the Texas’ instrastate rules. And in Madison, Wisconsin, a three-year-old brewery used the state’s rules to raise $67,000 in growth capital from 52 Wisconsin residents, almost all of whom were first-time business investors. The states’ progress offers optimism for what the SEC’s final rules can do for young businesses.
Rules adopted under Title III would extend the ability to use general solicitation to seek money from unaccredited investors across the country with certain restrictions. First, there are investing limits – the proposed Title III rules only allow participating companies to raise a max of $1 million in a year. Individual, non-accredited investors, may only contribute $2,000 or 5% of their annual income if their income or net worth is less than $100,000. If an investor’s income or net worth is more than $100,000, the investor can contribute 10% of that amount. Title III also amended the Securities Act, which requires issuers to file certain information with the SEC. And, it adds the requirement that transactions must be conducted through an intermediary that either is registered as a broker or is registered as a new type of entity called a “funding portal.”
On Friday, the SEC is set to discuss whether it will be adopting these proposed rules. The discussion will be held during an open meeting at 10:00 am in the Auditorium, Room L-002. More to come after the meeting…