Overview

The Securities and Exchange Commission (SEC) recently adopted Regulation Crowdfunding, which includes the final capital formation rules mandated by the Jumpstart Our Business Startups Act of 2012 (JOBS Act). The final rules set forth a new exemption under the Securities Act of 1933 that permits companies to offer and sell equity and debt securities to individuals through internet-based crowdfunding offerings, subject to certain specified investment limitations and offering requirements. This exemption will allow issuers to raise capital through smaller investments from a broader investor base.

Investment and Capital Raise Limits in Crowdfunding Offerings

Under Regulation Crowdfunding, there are certain limits on the amount that individuals may invest and the amount that issuers may raise through the crowdfunding process. These limits include:

Individual Investment Limits:

In any 12-month period, an individual is subject to the following aggregate crowdfunding investment limitations:

• Investors with either an annual income or net worth below $100,000 may invest the greater of (i) $2,000 or (ii) 5 percent of the lesser of the investor's annual income or net worth.
• Investors with both an annual income and net worth equal to or above $100,000 may invest 10 percent of the lesser of the investor's annual income or net worth.
• No investor may invest more than an aggregate of $100,000 in a 12-month period across all Regulation Crowdfunding offerings.

There are no restrictions on the types of investors that can participate in crowdfunding offerings, and the investment limitations apply to all investors alike.

Issuer Capital Raise Limits:

In any 12-month period, an issuer may sell up to $1 million of securities to investors in an offering made pursuant to the new exemption. This limitation also extends to predecessor entities and entities under common control.

Issuers Eligible to Conduct a Crowdfunding Offering

Only certain issuers are eligible to offer their securities under the new exemption. Ineligible issuers include foreign issuers, reporting companies under the Securities Exchange Act of 1934 (Exchange Act), investment companies under the Investment Company Act of 1940, bad actors, issuers required to provide crowdfunding disclosures that have become delinquent with their reporting obligations, issuers that do not have a specific business plan or purpose, or issuers that have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or unidentified companies.

Required Use of an Intermediary in Crowdfunding Offerings

Issuers must conduct a crowdfunding offering through an SEC-registered intermediary—either a single broker-dealer or funding portal. Offerings must be conducted online through the intermediary's platform, allowing for investor access to information and the free flow of information among potential investors. Intermediaries will be regulated by the Financial Industry Regulatory Authority and will be subject to a comprehensive regulatory framework similar to that required of broker-dealers.

Issuer Disclosure Requirements in Crowdfunding Offerings

The new crowdfunding rules include comprehensive disclosure requirements for issuers selling securities in reliance on the exemption. Issuers relying on the exemption must prepare an initial filing, amendment filings, periodic update filings, and termination filings. Issuers are required to file certain disclosures with the SEC using EDGAR and, in certain circumstances, provide them to investors and the intermediary. Failure to comply may result in potential enforcement action by the SEC.

Initial Filing (Form C):

This initial filing will require the following, among other things:

• Business Disclosure: Issuers will need to provide a description of the issuer's business; information regarding the issuer's directors, officers, and beneficial owners holding over 20 percent of the issuer's securities; discussion of the capital structure and indebtedness of the issuer; a description of certain related party transactions; a list of prior exempt securities offerings; U.S. GAAP compliant financial statements (the scope of which will vary by offering size); and management's discussion and analysis of financial statements.
• Offering Disclosure: Issuers will need to provide information regarding the targeted offering size; offering price; the method of valuation of securities offered; specific use of proceeds or possible uses of proceeds of the offering; the deadline for completion of the offering; risk factors; and transfer restrictions on the securities offered.

Amendments to Form C (Form C/A):

This filing will require that an issuer amend its disclosure within five business days of any material changes in either the offering terms or disclosure previously provided, as determined by the issuer. Materiality determinations will require the judgment of the issuer and should be made consistent with the SEC's current guidance on materiality. If material changes arise and are disclosed on this form, prospective investors will be required to reconfirm their investment commitments within five business days of receiving notice of any such change.

Progress Updates in the Offering (Form C-U):

This form must be filed with the SEC and provided to investors and the intermediary within five business days of certain milestones, including the following:

1. when the issuer receives commitments for 50 percent of the target offering amount;
2. when the issuer receives commitments for 100 percent of the target offering amount; and
3. when the issuer will accept commitments in excess of the target offering amount.

Annual Report (Form C-AR):

This filing must be made annually within 120 days of the end of the fiscal year covered by the form and must be posted on the issuer's website. The annual report must include information required in the offering statement, including information about previous failures to comply with ongoing reporting obligations. Financial statements must also be included and must be: (1) certified as true and complete by the issuer's principal executive officer; or (2) be prepared or reviewed by an independent certified public accountant, so long as neither preparation nor review by the independent certified public accountant is performed solely for the purpose of the annual report. Any material change to a previously filed annual form must be made as soon as practicable after the discovery of the material change. Issuers are not required to make any periodic reports other than the annual report.

Termination Report (Form C-TR):

This filing will terminate the issuer's reporting obligation and must be filed within five business days of the date on which the issuer becomes eligible to terminate its reporting obligations. An issuer's disclosure obligations terminate when:

1. the issuer is required to comply with Exchange Act sections 13(a) or 15(d) (that is, it becomes a public reporting issuer);
2. the issuer has filed at least one annual report on Form C-AR and has fewer than 300 holders of record;
3. the issuer has filed at least three annual reports on Form C-AR and has assets that are less than $10 million;
4. the issuer or another party purchases or repurchases all securities offered in the crowdfunding offering (this includes repayment of debt or redemption of redeemable securities); or
5. the issuer liquidates or dissolves under the state of its incorporation.

In certain circumstances, an issuer must also provide the above-mentioned forms directly to investors and the intermediary. The issuer can satisfy its requirement to deliver these forms to investors by directing investors via the issuer's website or by email to the information on the intermediary's platform.

Transfer Restrictions and Exchange Act Implications

Generally, securities purchased through a crowdfunding transaction may not be resold for one year. Additionally, the new rules exempt securities sold in crowdfunding offerings from the Exchange Act "holder of record" count for purposes of determining if registration of a class of equity securities is required under Section 12(g).

Timing

The forms enabling funding portals to register with the SEC will be effective January 29, 2016, and the rule is expected to be effective May 2016.