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D al l as Bar A ssoci ati on l Headnotes 17
Corporate Counsel & Securities
Equity Crowdfunding Under Regulation CF BY PATRICK H. ROSE, IV
Regulation Crowdfunding (Regulation CF) went live on May 16, 2016, giving emerging businesses a platform to raise up to $1 million through online equity crowdfunding. Crowdfunding is a tool used to fund projects by seeking small contributions from a large number of people, usually through the Internet. Millions of dollars have been raised for projects through crowdfunding sites like Kickstarter, where contributions are treated as donations or made in exchange for a product. But until Regulation CF, companies could not sell equity securities by online crowdfunding. To understand the significance of Regulation CF, a brief background on securities law is helpful. A security is an instrument that represents an investment in a common enterprise where the investor has a reasonable expectation of profits to be derived primarily from the efforts of others. Securities are offered by companies or government agencies (Issuer) to raise capital, usually as an alternative to traditional bank financing. An example of an equity security is stock in a company, and an example of a debt security is a bond issued by a company. Under the Securities Act of 1933 (Securities Act), securities offerings must be registered with the Securities and Exchange Commission (SEC) or qualify for an exemption from registration. SEC registration is a technical and expensive process that is mostly cost-prohibitive for emerging businesses. Issuers often rely on exemptions from SEC registration to raise capital through exempt securities offerings. The most common exemptions are
private offerings under Regulation D of the Securities Act, which normally target accredited investors (generally those with a net worth in excess of $1 million or annual income of $200,000 or more) or sophisticated investors (generally those who have the experience and knowledge to understand the related risks) and typically do not allow general solicitation. Because of these barriers, middle-class citizens have historically had few opportunities to invest in emerging businesses. The Jumpstart Our Business Startups Act (JOBS Act) was passed by Congress to help emerging businesses raise capital under less stringent securities regulations by creating new SEC registration exemptions. Title III of the JOBS Act created the crowdfunding registration exemption and required the SEC to promulgate crowdfunding rules. As a result, Regulation CF went into effect on May 16, 2016. Some states separately regulate crowdfunding, but those are not discussed herein. Regulation CF offering (CF Offering) criteria is Issuer friendly and investor protective. A non-exhaustive list is discussed below. Regulation CF imposes monetary limitations, both on the Issuer and investors. Issuers are limited to raising $1 million through CF Offerings in a 12-month period. Investors are limited to investments in all CF Offerings in a 12-month period as follows: (i) if annual income or net worth is less than $100,000, the greater of $2,000 or 5 percent of the lesser of annual income or net worth; and (ii) if annual income and net worth are both $100,000 or more, 10 percent of the lesser of annual income or net worth (not to exceed $100,000). Each CF Offering must be distributed exclusively through a single online plat-
form that is operated by an intermediary who is either a registered broker-dealer or a funding portal that is registered with the SEC and FINRA. Popular portals are Wefunder and SeedInvest. An Issuer must be organized in the United States and must file its offering statement on Form C with the SEC and through the intermediary. The Form C information includes information about the Issuer’s ownership/management; description of the business; price of the securities; target offering amount; related party transactions; and financial information. The Issuer must also generally provide progress updates, an annual report, and comply with ongoing reporting requirements. An Issuer may only advertise a CF Offering with a “tombstone” notice that directs investors to the intermediary’s platform and includes no more than the following: (i) the Issuer is conducting a CF
Offering, the name of the intermediary, and a link to the platform; (ii) the basic terms of the offering; and (iii) the name, address, phone number, and website of the Issuer, the email address of the Issuer representative, and a brief description of the business. Once investors have reached the platform, the Issuer may discuss the CF Offering in detail through the platform. Lastly, securities sold through a CF Offering cannot be transferred by an investor within one year except (i) to the Issuer; (ii) to an accredited investor; (iii) through an SEC registered offering; or (iv) to a family member or trust of the investor. While the impact of Regulation CF is yet to be seen, it gives emerging business HN unprecedented access to capital. Patrick H. Rose, IV is a corporate and real estate attorney at Kane Russell Coleman & Logan PC. He can be reached at prose@ krcl.com.
CIC NEEDS YOUR DONATIONS The DBA Community Involvement Committee is collecting gently used men and women’s suits, coats, dress clothes, and accessories (including dress shoes, shirts, belts and ties). Benefits the Dallas Life Foundation Drop off donations Friday, December 9, 9:00 a.m. to noon at Belo (circle drive). For more information, contact kzack@dallasbar.org.