Crowdfunding is a financing method that raises money through soliciting relatively small individual investments or contributions from a large number of people.
Specific Securities and Exchange Commission (SEC) regulations exist for companies hoping to carry out securities offers through crowdfunding. According to Regulation Crowdfunding, a company must register with the SEC before making any offer or sale of security, unless said company is exempt.
The Securities Act of 1933 required registration of any offer and sale of securities, absent an available and applicable exemption from registration. The Jumpstart Our Business Startups Act enacted in 2012 loosened some regulations regarding the offer and sale of private securities. In particular, Securities Act Section 4(a)(6) of the JOBS Act allows certain crowdfunding transactions exemption from registration. In 2015, the Commission adopted Regulation Crowdfunding, which allowed eligible companies to raise funds via Regulation Crowdfunding beginning May 2016.
What is Regulation CF?
Regulation Crowdfunding offers an exemption for taking out registration requirements for securities-based crowdfunding. In return, a company can show and sell securities amounting to $5 million without having to register its offering with the SEC. This Regulation offers vast opportunities for start-ups and small businesses to raise capital quickly. Regulation CF allows anyone from the general public to make an investment. Investing under Regulation CF can be volatile, however, making 12-month investment limits imperative. The amount one can invest varies, as it is wholly dependent on one’s net worth and annual income.
Requirements of Regulation CF
According to SEC.gov, Regulation CF:
- Limits how much money a company can raise in a 12-month period to $5,000,000
- Requires all transactions under Regulation Crowdfunding to take place online through an SEC-registered intermediary, e.g. a broker-dealer or funding portal registered with the SEC and the Financial Industry Regulatory Authority
- Limits how much a non-accredited investor can invest
- If an investor’s annual income or net worth is less than $107,000, the investment limit is 5% of the greater of your annual income or net worth
- If an investor’s annual income and net worth are $107,000 or greater, the investment limit is 10% of the greater of income or net worth
- Requires issuers to disclose information to potential and current investors
- Limits advertising and promoters by requiring an issuer to disclose if he or she compensates others to promote his or her offerings. An issuer may not advertise the terms of an offering except in a notice that directs investors to an intermediary’s platform and includes no more than:
- Statement that an issuer is conducting an offering through a Regulation Crowdfunding intermediary (name of the intermediary), and a link to an intermediary’s platform;
- Terms of an offering: amount, price, nature of any securities, and a closing date for an offering period;
- Legal identity and business location of an issuer--issuer’s name, address, phone number, website, email address of issuer’s representative, and a brief description of an issuer’s business
- Requires that investors have up to 48 hours to cancel an offering investment; or up until the offering closing if the investment is made fewer than 48 hours before closing
- Restricts resale of transactions within a 12-month period, unless securities are transferred:
- To an issuer of said securities
- To an accredited investor
- As part of an offering register with the SEC
- To a family member of a purchaser or equivalent: a trust controlled by the purchaser, a trust created for the benefit of a family member of the purchaser, or in connection with the death or divorce of the purchaser or similar circumstances
- Disqualifies offerings if the issuer or other covered persons have experienced a disqualifying event, such as being convicted of securities fraud
- Set rules for establishing a new Special Purpose Vehicle (SPV) called Crowdfunding Vehicle under Regulation CF. This space is for investors hoping to keep their shares without introducing cap table (Section 12(g) of the Exchange Act) concerns for issuers
- Established rules for "Testing the Waters" Communication
- People who intend to invest under Regulation CF can legally generate oral or written solicitations before completing Form C. They can also solicit investor interest before choosing their preferred exemption, "testing the waters" before choosing an intermediary platform and beginning the Regulation CF offering process
Who is Eligible to Raise Capital Under Regulation CF?
According to Securities Act Section 4A(f), certain issuers are exempt from relying on Regulation CF. Exemptions apply to:
- Unorganized companies within the US and Canada
- Companies required to submit Exchange Act reports
- Companies disqualified as a result of being included in the "covered persons," or people affiliated with the issuer and connected with the offering
- Companies that have not submitted annual reporting requirements under Regulation CF over two years
- Companies that failed to establish a tangible business plan
- Companies planning on executing a merger
How are offerings and investments under Regulation CF managed?
An investment limit determines the particular amount that investors can provide across all offerings and issuers over 12 months. Under Regulation CF, investments can rise to more than $2,000 or 5% of the greater of the investor's annual income or net worth. This stipulation is for investors earning less than $107,000 annually. Different rules apply for investors with more than $107,000 annual income and net worth. Their investment cannot go beyond the amount sold of $107,000 or 10% of the greater of the investor's annual income or net worth. For example, an investor earns $50,000 per year, but his or her net worth is $105,000. In this case, he or she can only invest $5,250 under Regulation CF.
The SEC established Regulation CF to protect companies and investors with a sizable gap between net worth and annual income. Smaller businesses and start-ups often take the most hit under crowdfunding exemption. With a lower investment limit for investors who have a net worth or annual income below $107,000, potential losses are often limited. As a result, these companies would bear the risk of casualties regardless of a low success rate.
How to Prepare for a Regulation CF Offering
Raising capital through Regulation CF requires coordination with a Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) registered broker-dealer or funding portal. The issuing company must create and submit a Form C with the SEC. A business should complete this form before making an offering or raise.
Launching a Raise
A company can only begin launching its equity crowdfunding campaign after filing Form C with the SEC. Filing with the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system can take a couple of hours to ensure complete compliance.
A company is not allowed to close any investments for 21 days after listing its Regulation CF offering with a funding-portal, making way for investors taking time to proceed with their investment decisions.
Making Specific Changes to an Offering
Businesses must contact their investors frequently before any potential concerns become detrimental issues.
If a company is looking to change its offering's material, all investors must be notified accordingly. Investors then have at least five business days to either change their decisions or re-confirm their investments. If an investor fails to respond to a material change within five business days, the system will automatically cancel his or her investment.
Before closing an offering, all investments are memorialized. A company can review its portfolio of assets and its summary after closing.
Investors are also permitted to cancel their investment decisions for whatever reason at least 48 hours before an offering closes.