The SEC’s proposed new rules on equity crowdfunding prohibit the offer or sale of G take various steps to reduce the On 23 October 2013, the United securities. Thus, they do not run risk of fraud; States Securities and Exchange afoul of the US securities laws, G make available information Commission (‘SEC’) unanimously which place substantial restrictions about the company and the voted to propose rules permitting on the offer and sale of ; equity crowdfunding as required by to the general public. G provide communication Some features of the SEC’s channels to permit discussions Title III of the Jumpstart Our proposal include the following1: about offerings on the platform; Business Startups (‘JOBS’) Act. G The total amount sold by the and Under the proposal a company company to all , including G avoid offering investment would be permitted to use a amounts sold in reliance on this advice or making crowdfunding exemption, during recommendations. crowdfunding portal to offer the preceding 12 months may not Companies would be required to securities and raise up to $1 million exceed $1 million; provide financial disclosures to in any 12-month period from an G There is no minimum net potential purchasers that would unlimited number of investors worth or financial sophistication vary based on the size of the regardless of their net worth or requirement imposed on investors offering. For offerings that have in wishing to participate in a the aggregate, together with all sophistication. The proposed rules crowdfunded offering; other crowdfunding offerings by are subject to a public comment G The total amount sold to any the company in the past 12 period and the SEC would be single by the company, months, target offering amounts required to take further action in including amounts sold in reliance of: on the crowdfunding exemption, G $100,000 or less: the company order to enact the proposed rules during the preceding 12 months would be required to provide into law. Scott H. Kimpel, Partner at may not exceed: income tax returns for its most Hunton & Williams LLP, Washington a/ if either the annual income or recently completed year and DC, explains the proposed rules net worth of the investor is below financial statements certified by the and the doubts expressed by some $100,000, the greater of $2,000 or principal executive officer; 5% of the annual income or net G more than $100,000 but less that the SEC’s rules will fail to create worth of that investor; and than $500,000: the company would a vibrant crowdfunding market. b/ if either the annual income or be required to provide financial net worth of the investor is statements reviewed by a public $100,000 or more, 10% of the accountant that is independent of Crowdfunding is a subset of the annual income or net worth of the the company; and movement. At a investor (up to a maximum G more than $500,000: the typical crowdsourcing website, the aggregate amount sold of company would be required to party seeking financing posts a $100,000). provide audited financial project proposal online and states a The transaction would be statements. funding goal. Potential required to be conducted through Companies offering securities via contributors then visit the website a registered securities broker or a crowdfunding would be required and donate funds to support the new kind of intermediary known to prepare an offering statement project. Sometimes, but not always, as a ‘funding portal.’2 that would be filed with the SEC, the patrons get free samples of the The proposed rules would provided to its intermediary and entrepreneurs’ products in generally require intermediaries to: made available to investors. Among exchange for their donations. If G have a reasonable basis for other things, the offering statement and when projects meet their believing that the crowdfunding would be required to disclose: funding goals, the crowdfunding company is complying with the G information about the website takes a small percentage of applicable rules; company’s officers, directors and the funds generated and transfers G ensure that the company’s 20% owners; the balance to the projects’ disclosure documents are made G a description of the company’s creators. At this time, most publicly available for 21 days business and business plans, crowdfunding sites operating in before securities are sold; number of employees and the use the United States or seeking funds G provide investors with of proceeds from the offering; from US residents generally educational materials; G information about the risks of

10 E-Finance & Payments Law & Policy - January 2014 CROWDFUNDING

the offering; Minority crowdfunding is to create a simple, Minority investors will have the G the price to the public of the investors will inexpensive way for garage start- benefits of various statutory securities being offered, how their have the ups and other smaller businesses to protections and fiduciary regimes valuation was determined, the benefits of raise capital without the need to designed to constrain the activities various target offering amount, the statutory rely heavily on lawyers, investment of management and controlling deadline to reach the target and protections bankers and other intermediaries. shareholders. Thus, the founders whether the company will accept and fiduciary The SEC’s proposed rules, which may be limited in their ability to capital in excess of the target; regimes closely track the JOBS Act’s make decisions about the G information about related- designed to mandates, would create a system operation of the business if those constrain the party transactions; activities of that is anything but simple and decisions could disadvantage G information about the management inexpensive. Preparing financial minority investors. Looking ahead financial condition of the and statements, drafting lengthy to future fundraising, more- company; and controlling disclosure documents, retaining sophisticated investors, such as G financial statements that, shareholders. brokers or funding portals, and and depending on the target amount undertaking an annual reporting funds, may be discouraged from offered in crowdfunding obligation to the SEC - all for investing in a business that has a transactions during the trailing 12- gross proceeds less than $1 million complicated capital table with a month period, would have to be annually - seem a heavy lift for any large retail investor base. accompanied by a copy of the small business, particularly one Given the onerousness of the company’s tax returns or reviewed seeking seed capital. Other proposed rules and the other or audited by an independent permissible techniques for factors described in this article, public accountant. privately raising capital exist, and many observers have expressed Companies would be limited in these other techniques are neither doubts as to how vibrant a market their ability to advertise the as complicated as the SEC’s will develop in the SEC-regulated offering outside of the crowdfunding model, nor are they crowdfunding space. Nevertheless, crowdfunding portal. limited to $1 million in total numerous businesses have Companies that complete a proceeds. Indeed, the SEC recently commenced operations in crowdfunded offering would have created a new private placement anticipation of the crowdfunding an ongoing requirement to provide exemption under its Rule 506(c) rules’ adoption and hope to an annual report describing their that permits a company to publicly capitalise on this new fundraising operations and financial condition advertise a private securities technique by offering their services to the SEC. The crowdfunding offering so long as the universe of to companies and investors. Time exemption would not be available subscribers is limited to investors will tell if the promise of equity to public companies already filing meeting minimum net-worth crowdfunding is to be fulfilled. reports with the SEC, companies requirements. Furthermore, the incorporated outside the United SEC staff have recently permitted a Scott H. Kimpel Partner Hunton & Williams LLP, Washington DC States, registered mutual funds and number of limited-purpose [email protected] certain private investment funds, crowdfunding portals to and various other types of special- commence operations on the 1. The complete proposal is available at purpose companies that would be condition that they only allow www.sec.gov/rules/proposed/2013/33- 9470.pdf disqualified under the proposed ‘accredited’ investors meeting 2. Finra, another regulatory body that rules. Because there has been some minimum net-worth requirements oversees US broker-dealers, has also confusion in the marketplace, it is to participate. Any private proposed rules governing the registration and operations of funding portals. worth remembering that a company considering a 3. Available at http://www.sec.gov/ company may not conduct a crowdfunded offering must be news/press/2011/2011-122.htm crowdfunded securities offering to aware of the potential burdens a the general public until such time large group of minority as the SEC adopts final rules. As a shareholders could impose. A cautionary note, in 2011, the SEC corporation with large numbers of shut down ‘buyabeercompany.com’ shareholders must develop a because in effect it was conducting system for tracking its investor base an unregistered crowdfunded and ensuring that required offering to the public3. communications are distributed to The promise of equity investors in a timely fashion.

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