The JOBS Act takes the unprecedented step of permitting crowdfunding. The statute permits, subject to SEC rulemaking, the ability to offer and sell securities to numerous people that do not have to qualify as accredited investors without registration under the Securities Act.
Entrepreneurs seriously considering crowdfunding will need to carefully think through the implications:
- The JOBS Act requires certain financial and other information be filed with the SEC. We assume anything filed with the SEC will be publicly available. Therefore, entrepreneurs need to be comfortable that their relatives, neighbors, friends, vendors, customers and present and potential competitors will have this information available.
- The JOBS Act specifies the type of financial information that must be given to investors. Any entrepreneur anticipating raising substantial amounts through crowdfunding would be well advised to have audited financial statements prepared, or at the very least, reviewed financial statements.
- Crowdfunding under the JOBS Act has long term implications which need to be evaluated, including filing annual financial information with the SEC and providing it to investors. Therefore, it may not be advisable to use crowdfunding to bridge short-term funding needs.
- Acquiring numerous shareholders through crowdfunding can have unintended consequences. It likely will make investments by venture capital groups impossible and can significantly complicate or block an exit. An entrepreneur can lose control of his or her company. It will require an entrepreneur to function as an investor relations officer and respond to numerous inquiries from shareholders. Lastly, the likely impersonal nature of crowdfunding increases the possibility of attracting disruptive investors.
Specific information on the requirements for issuers are discussed below.
Limitations on Sales
The statute limits sales as follows:
- Not more than $1,000,000 in sales may be made in the preceding 12-month period. It is important to note that this refers to all sales, not just those in reliance on the crowdfunding exemption.
- The aggregate amount sold to any investor (no matter what exemption is relied upon) in the preceding 12-month period cannot exceed:
- the greater of $2,000 or 5 percent of the annual income or net worth of such investor, if either the annual income or the net worth of the investor is less than $100,000, and
- 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.
The income and net worth tests are calculated in the same manner as that used for an accredited investor. As a result, the value of the primary residence of an individual investor cannot be included when calculating net worth.
Limitations on Who Can Sell the Securities and How
Only brokers, or a new type of regulated entity, called a “funding portal,” can “conduct” the transaction.
Issuers may not advertise the terms of the offering, except for notices that direct investors to the funding portal or broker. In addition, issuers cannot compensate any person to promote its offerings through communication channels provided by a broker or funding portal, without taking such steps as to ensure that such person clearly discloses the receipt of such compensation, as determined by SEC rules.
Limitations on What Type of Entities Can Raise Money Using Crowdfunding
The following types of entities cannot use the crowdfunding exemption:
- entities not organized under the laws of any state or territory of the United States;
- entities which are public;
- “investment companies” and those entities that are not investment companies under Section 3(b) and 3(c) of the Investment Company Act. What this means in plain English is you cannot use the crowdfunding exemption to start a private equity or hedge fund.
- other types of entities the SEC may designate.
In addition, the SEC is directed to issue rules containing “bad boy disqualifiers” that will preclude disqualified issuers from using the crowdfunding exemptions. These disqualifiers are expected to look through the issuer to directors, officers, general partners and 10% owners for certain matters.
Information that Must be Filed With the SEC and Given to Others Prior to Sale
Certain information must be filed with the SEC and given to brokers, funding portals, investors and potential investors.
The financial information that must be filed with the SEC and disseminated to designated persons includes a description of the financial condition of the issuer, which means:
- for offerings that, together with all other offerings of the issuer under the crowdfunding exemption within the preceding 12-month period, have, in the aggregate, target offering amounts of
- $100,000 or less–
- the income tax returns filed by the issuer for the most recently completed year (if any); and
- financial statements of the issuer, which must be certified by the principal executive officer of the issuer to be true and complete in all material respects;
- more than $100,000, but not more than $500,000, financial statements reviewed by a public accountant who is independent of the issuer, using professional standards and procedures established by the SEC, and
- more than $500,000 (or such other amount as the SEC may establish), audited financial statements.
- $100,000 or less–
Other information which must be filed with the SEC and given to brokers, funding portals, investors and potential investors includes:
- the name, legal status, physical address, and website address of the issuer;
- the names of the directors and officers and each person holding more than 20 percent of the shares of the issuer;
- a description of the business of the issuer and the anticipated business plan of the issuer;
- a description of the stated purpose and intended use of the proceeds of the offering sought by the issuer with respect to the target offering amount;
- the target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target offering amount;
- the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities; and
- a description of the ownership and capital structure of the issuer that meets certain specific requirements.
Information that Must be Filed With the SEC Annually and Given to Investors
The JOBS Act provides that not less than annually, crowdfunding issuers must file with the SEC and provide to investors reports of the results of operations and financial statements of the issuer, as the SEC determines by rule.
Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.