The SEC Responds to Investment Crowdfunding's $67.3 Billion Raises in 2019 with Increases in Dollar Caps and Certain Restrictions Loosened
Introduction
Investment crowdfunding is now a multi-billion dollar industry. It has helped thousands of small businesses facilitate capital through the democratization of investment opportunities for non-accredited investors. As such, more and more people are becoming investors, and more and more small businesses are getting the capital that they need and would otherwise not have access to. Soon, crowdfunding will be available to many more people, hopefully leading to a more racially and economically diverse industry.
The SEC has made a number of changes to investment crowdfunding in response to its increased use over the past few years. For instance, the SEC estimated that in 2019 alone, offers conducted under Rule 506(c) generated $66,000,000,000; offers conducted under Regulation A+ Tier 2 (Reg A+ Tier 2) generated $998,000,000, just $2 million shy of $1 billion; offers conducted under Rule 504 of Regulation D (Direct Public Offering or DPO) generated $228,000,000; and offers conducted under Regulation Crowdfunding (Reg CF) generated $63,000,000. As such, the SEC increased the maximum allowable amounts that can be conducted under Reg A+, DPO, and Reg CF.
In addition, the SEC made other rule changes to investment crowdfunding that would further increase its use. This includes changes to how Reg CF issuers may communicate their offers and generate interest from potential investors; how issuers may conduct multiple offers at the same time; and the ability of Reg CF issuers to use Special Purpose Vehicles (SPVs) to help with the management of its multitude of investors. This article will provide more detail of the aforementioned changes, except the change surrounding SPVs will be discussed in a separate article entitled "Who Cares About Special Purpose Vehicles (SPVs) Anyway?" Go to http://www.elcesq.com/writings to learn how this special tool will forever change the crowdfunding industry.
Investment Dollar Caps Increases
Due to the recent SEC changes, Reg CF issuers can now raise up to $5MM (formerly $1.07MM) in a 12-month period. Likewise, DPO issuers can now raise up to $10 million (formerly $5MM) in a 12-month period. And, lastly, Reg A Tier 2 issuers can now raise up to $75MM (formerly $50MM) within a single year.
Furthermore, the SEC removed the individual investor cap that previously existed for Reg CF accredited investors. Now, these wealthy investors can provide an unlimited amount of capital to a Reg CF offer. The SEC even made it easier for non-accredited investors to invest in a Reg CF offer. Although, an individual cap still exists for non-accredited investors, it will now be calculated based upon the greater of the investor's income or net worth instead of using an obsolete mathematical formula.
Lastly, in light of COVID-19's plaguing small businesses everywhere, Reg CF offers between $100k-250k will now be eligible for filing expedition and will no longer need to attach audited financial statements by a certified public accountant with their Form C filings. Instead, the SEC will now allow the submission of financial statements that are merely certified by the issuer's chief executive officer. This Covid-19 relief will continue until year 2022. Unfortunately, there was no filing change to Reg CF offers above $535k. These offers will still have to provide audited financial statements with their Form C applications.
"Testing the Waters" Doctrine
Other SEC changes include applying the Reg A+ “testing the waters” rules to Reg CF offers. Previously, “testing the waters” was an act of engaging the public through general solicitation and advertising in order to evaluate investors’ interest in a Reg A+ offer prior to filing and incurring costs of conducting the actual offer. Other types of offers, such as Reg CF, did not have this feature and small business issuers conducting Reg CF offers were required to have their offer qualified by the SEC before engaging in public advertising and general solicitation.
Now, Reg CF issuers (and issuers of other exempt offerings) can take advantage of these rules and build a crowd of supporters prior to filing or bearing the costs of officially launching their offerings. Any crowdfunding platform will tell you that for a small business issuer to be successful at reaching their crowdfunding goal, they should have already built a crowd of interested investors prior to putting their offers on a platform. Too many small businesses enter into the crowdfunding space with the belief that if they simply launch their campaigns on a platform, then the crowds will come. This is simply not true. Lucky for them though, under the new rules, they can now legally garner interest and build a following prior to launching their offers. Of course, they are advised to consult an attorney to help with drafting the appropriate language and setting up the right procedure for garnering this interest.
Other legal requirements include maintaining copies of all "testing the water" materials and filing them with the SEC when the issuer does decide to conduct an actual offer. The issuer must also ensure that the "testing the water" materials include a disclaimer that states that all solicitation of interests are non-binding, and that any money received by an interested investor will be returned. It is super important that the issuer makes sure that no money ever exchanges hands until an actual offer is filed and qualified by the SEC.
"Demo Day"
"Demo Day" is similar to "testing the waters" in that it provides small business issuers with the opportunity to publicly advertise and generally solicit interest from investors without violating SEC registration rules. However, "Demo Day" involves more than a solicitation of interest. Rather, it is a forum for small business to conduct an actual offer with the intent of securing an investment through negotiation, and possibly an exchange of money or the signing of a term sheet.
This new rule allowing for "demo days" is great for small businesses. Still, it is not without its own restrictions. For instance, only government agencies, higher education institutions, nonprofit organizations, angel investor groups, and business incubators/accelerators, can be organizers or sponsors of "demo day" events. Additionally, sponsors of "demo days" are restricted from charging participants entry fees that exceed their administrative costs nor can they receive compensation for assisting with negotiations or making introductions between issuers and investors. Sponsors are also prohibited from making recommendations or providing investment advice to attendees. These "demo day" sponsors must also ensure that the event has more than one participating business and that all advertising materials regarding the event refrain from referencing any particular offer.
Integration Rules
Another important change regarding investment crowdfunding involves the rules surrounding “integration.” Integration is the act of conducting multiple offers too close in time so much so that you blend multiple offers into one, especially where such offers are part of a single plan of financing or are made for the same general purpose. This will likely result in the small business issuer violating certain SEC exemption and registration rules. As such, it is very important that small business issuers pay particular attention to these rule changes.
After all, the whole allure to crowdfunding offers is the exemption from registering with the SEC. Luckily, the SEC already has certain safe harbors regarding integration when it comes to both Reg CF and Reg A+ offers. For instance, there is no integration of prior offers, including private offers, that came before a Reg A+ offer nor is there integration when a small business conducts a Reg CF offer after conducting a Reg A+ offer and vice versa. This is also true for other offers conducted simultaneously with Reg A+ offers so long as the small business issuer complies with the exempt rules for each offer. This includes ensuring that investors of a private offering that is conducted simultaneously with a Reg A+ offering are obtained without the use of public advertising or general solicitation, and that such investors are sophisticated as defined by securities laws.
Now, the new SEC integration rules make the “simultaneous rule” described in the Reg A+ context the general rule for all offers, and not just Reg A+. Also, if an issuer is still not sure when to conduct its next offer, the new rules provide for a safe harbor period of thirty (30) days between two different offers which is a significant change from the prior six (6) month safe harbor rule. Still, the issuer will need to do its due diligence to ensure that private offers conducted 30 days after a crowdfunding offer were offered privately and not through any general solicitation means.
Conclusion
In conclusion, investment crowdfunding is becoming more popular and new rules are needed to compensate for this surge in use. It is also important to note that the SEC has been conducting studies of investment crowdfunding since its inception in 2012. Thus, the rules around investment crowdfunding is always changing. Therefore, it is important that small business issuers and crowdfunding platforms seek appropriate legal support when conducting and managing new offers. If you are currently in need of legal support, please do not hesitate to contact the crowdfunding securities law firm Elizabeth L. Carter, Esq., LLC at info@elcesq.com