On October 30, 2015, the Securities and Exchange Commission (SEC) adopted new Regulation Crowdfunding to implement the requirements of the Jumpstart Our Business Startups Act. Regulation Crowdfunding prescribes rules governing the offer and sale of securities under Section 4(a)(6) of the Securities Act and provides a framework for the regulation of registered funding portals and broker-dealers that issuers are required to use as intermediaries in the offer and sale of securities in reliance on Section 4(a)(6). Regulation Crowdfunding is generally effective May 16, 2016, except for rules related to the registration of funding portals and amendments to Form ID, which became effective on January 29, 2016.
The SEC issued an Investor Bulletin, Crowdfunding for Investors on February 16, 2016 to educate investors about Regulation Crowdfunding and to explain this new investing opportunity — securities–based crowdfunding, which is different from websites raising funds and offering in-kind consideration for financial contributions. Starting May 16, 2016, the general public will have an opportunity to invest in start-ups and early stage companies and receive equity consideration for their investments.
Who Can Make a Crowdfunding Investment?
The main idea of crowdfunding is that everybody can invest. However, because of the risks involved in this type of investing the SEC limited the amount of funds that can be invested in crowdfunding offerings during any 12-month period by establishing certain net income and net worth limitations.
The SEC offered helpful plain English examples and tables to illustrate investor eligibility requirements, as well as how to calculate net worth.
- if either your annual income or your net worth is less than $100,000, then during any 12-month period, you can invest up to the greater of either $2,000 or 5% of the lesser of your annual income or net worth; and
- if both your annual income and your net worth are equal to or more than $100,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $100,000.
The SEC has clarified that married couples can calculate their annual income or net worth jointly, but then each of their crowdfunding investments together cannot exceed the limit that would apply to an individual investor at that annual income or net worth level.
How to Calculate Net Worth?
The SEC explained that in order to calculate net worth, an investor needs to add up all of his or her assets and then subtract all liabilities. Similar to the approach used in the accredited investor definition, the value of an investor’s primary residence is not included in the net worth calculation, and any mortgage or other loan on the home does not count as a liability up to the fair market value of the home. If the loan is for more than the fair market value of the home, then the loan amount that is over the fair market value would be counted as a liability under the net worth test. Further, any increase in the loan amount in the 60 days prior to the purchase of securities (even if the loan amount does not exceed the value of the residence) will also count as a liability.
How to Make a Crowdfunding Investment?
The SEC reminded investors that they can only invest in a crowdfunding offering through the online platform (a website or a mobile app) of a broker-dealer or a funding portal, i.e., —a crowdfunding intermediary that must be registered with the SEC and be a member of the Financial Industry Regulatory Authority.
How to Get Informed?
The SEC stressed that companies engaged in crowdfunding offerings are required to disclose certain information, including general information about the company, its officers and directors, a description of the business, the use of proceeds, the target offering amount, the deadline for the offering, related-party transactions, risks specific to the company or its business, and financial information about the company. The Investment Bulletin states that the minimum level of financial disclosure required by the company depends on the amount of money being raised or raised by the company in the prior 12 months:
- $100,000 or less – financial statements and specific line items from income tax returns, both of which are certified by the principal executive officer of the company;
- $100,000.01 to $500,000 – financial statements reviewed by an independent public accountant and the accountant’s review report; or
- $500,000.01 to $1 million – if first time crowdfunding, then financial statements reviewed by an independent public accountant and the accountant’s review report, otherwise financial statements audited by an independent public accountant and the accountant’s audit report.
An investor also has up to 48 hours prior to the end of the offer period to cancel his or her investment commitment for any reason. However, once the offering period is within 48 hours of ending, an investor will not be able to cancel even if such investor made the commitment during this period. However, if the company makes a material change to the offering terms or other information disclosed to investors, then an investor will be given five business days to reconfirm his or her investment commitment.