Equity Crowdfunding Rules Q&As

us-capitol

On October 23rd, 2013, the Securities and Exchange Commission issued
 proposed rules for the implementation of equity crowdfunding as outlined in 
Title III of the JOBS Act. These regulations have the potential to change
 the entire landscape of fundraising for private companies. The crowdfunding model has already proven successful in helping entrepreneurs raise the funds they need to turn ideas into reality through donations. Now, the model of sourcing capital from a wide audience can be applied to the private securities market.

When Title III of the JOBS Act is implemented (likely in the first half of 2014), all Americans, regardless of income or net worth, will be able to invest in private companies. Currently, only the 8.7 million households that qualify as accredited investors are able to invest in private offerings, but that will increase at least 10 fold with the new guidelines, providing a whole new asset class for non-accredited investors. Because individuals are able to invest as little as $1000 in a private company, the exponential reach will benefit entrepreneurs significantly, further democratizing the access to early-stage capital to build the businesses of tomorrow.

What are some important things you need to know about this?

What does the SEC ruling mean for startups in need of capital?

Startups will be able to receive investments from an exponential number of potential investors through Title III. With the ability to generally solicit – publicly advertise – their offerings (through Title II, which was implemented on September 23, 2013), businesses will be able to reap the benefits of technology and social networks to reach and engage their biggest supporters – customers, fans, and casual investors.  Title III of the JOBS Act, together with Title II, breaks down many of the barriers that entrepreneurs face in raising capital, not the least of which is reaching a geographically and economically diverse audience to help fund their business en masse.

On the other hand, startups will be required to abide by new guidelines in order to comply with the SEC’s regulations, as suggested in the proposed rules. These include, among many others, the filing of Form C as an offering statement and other financial documentation depending on the size of the round (maximum raise of $1 million per year).

Are all startups eligible be able to take advantage of equity crowdfunding?

Not all companies will be able to use the crowdfunding exemption.  Ineligible companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies, companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

What are the benefits of the new ruling?

Same as above: Startups will be able to receive investments from an exponential number of potential investors through Title III. With the ability to generally solicit – publicly advertise – their offerings (through Title II, which was implemented on September 23, 2013), businesses will be able to reap the benefits of technology and social networks to reach and engage their biggest supporters – customers, fans, and casual investors.  Title III of the JOBS Act, together with Title II, breaks down many of the barriers that entrepreneurs face in raising capital, not the least of which is reaching a geographically and economically diverse audience to help fund their business en masse.

Investors will benefit by gaining access to a new asset class in which to invest, with a wide variety of deal flow for private offerings. For the first time in 80 years, non-accredited investors (99% of the population) will be able to participate in startup investment opportunities, into which the wealthy have poured money.

What are downsides of the new ruling?

Depending on the final rules (to be determined after the commenting period set forth by the SEC), startup founders may find that the additional regulatory requirements are too burdensome to warrant crowdfunding under these guidelines.  Startups should carefully consider all of the options to raise capital and understand the net effect of the benefits and the additional requirements on an individual basis.

Investors will likely experience a marked increase of private offerings in the marketplace and would be well advised to carry out their own due diligence on each private offering they are considering for investment.  Investors who are considered non-accredited according to the SEC’s definition will only be able to invest 5% or 10% of their annual income per year in crowdfunded offerings as a means of limiting the potential downside associated with these types of investments.

How easy will it be for startups to sell “shares” of their company through equity crowdfunding? How will they value these shares?

There will be a fair amount of work that goes into preparing a company to sell “shares”, including have a well thought through business, a detailed business plan and financials, a legal entity in which the company is incorporated, verification checks on all officers, majority stakeholders and the business itself, and have, at the very least, a minimum viable product.

Price per share and terms of their raise will be carefully crafted in efforts with the company’s respective legal team and advisory board.

Will startups be required to use a site like RockThePost, or can they fundraise through other means as well?

Startups will be able to collect investments via startup investing platforms like RockThePost as well as through independent means such as their own website or marketing efforts. When startups take it upon themselves to crowdfund, however, they must be very diligent to comply with the SEC regulations so as not to be labeled as a “bad actor” that will be banned from fundraising for a year, as proposed in the Title II amendments.

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