April 21st, 2017
11 Big Questions Heading Into Tomorrow’s SEC Crowdfunding Vote
Crowdfund Insider | | Oct 29, 2015
At long last (3 years, 6 months, 25 days since we will get Title III equity crowdfunding rules tomorrow signing of the JOBS Act to be exact), it looks like we will get Title III equity crowdfunding rules tomorrow, potentially opening up a new novel avenue for small businesses to raise capital.
When the original rules were proposed back in October of 2013 (Proposed Rules), there were several fundamental problems that threatened to make equity crowdfunding unworkable. Tomorrow we will find out how (if) these issues were addressed as well as what other surprises the SEC might have in store. Here are 11 key questions to keep in mind as we tune in to hear the historic vote tomorrow at 10:00 am:
1) Will there be a “testing the waters” provision to allow companies to test demand before going through an expensive legal and audit process?
One of the biggest concerns many issuers will have about using crowdfunding is that they will have to spend a lot of time and money on legal and accounting costs without knowing if there is investor demand. Thus a company would have to gamble on their crowdfunding offering. Regulation A allows companies to test investor demand before filing documents. We’ll see if the SEC is willing to apply the same rationale to crowdfunding offerings.
2) Will on-going disclosure and reporting with the SEC continue to be required?
Under the proposed rules, crowdfunded companies would have to continue to file ongoing annual reports with the SEC, much like a public company. To me, this is the most problematic piece of the proposed rules. The ongoing costs and disclosure requirements of essentially becoming a mini-public company make this a very difficult pill to swallow for most smaller companies. The SEC has discretion under the statute to reduce or eliminate (through exemptions) these ongoing requirements. Some have suggested several possible exemptions to these requirements, including exemptions for “main street” small businesses.
3) Will audited financials be required?
One of the biggest concerns with the proposed rules and the JOBS Act rules was the requirement for audited financials for offerings greater than $500k. An audit can cost upwards of $20,000 and take several weeks, a cost prohibitive requirement for offerings less than $1M. Moreover, the expense would be required before an issuer even knows whether there is any investor demand. (see #1 above) There has been overwhelming push back on this and the SEC has the authority to raise this limit to $750k or even $1M (effectively killing the requirement).
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The proposed rules present a very detailed list of disclosure items similar to a full-fledged Private Placement Memorandum, which must be filed with the SEC and made publicly available. The specific requirements went beyond what was actually required under the statute, so the SEC could theoretically pull back here. While still burdensome, there are now vendors who seek to streamline this process in a cost-effective manner, including iDisclose and CrowdCheck.
5) Will holding companies be allowed?
Many companies considering crowdfunding balk at the thought of having thousands of shareholders on their cap table. Under the prior rules, pooling crowdfunders into a holding company was not allowed. Since then, various parties have suggested the creation of a crowdfunding special purpose vehicle entity to help solve this problem. The SEC could create a new specific crowdfunding structure or clarify that holding companies can be allowed under certain circumstances.
6) Will equity or carried interest be allowed?
Previous rules prohibited funding portals from receiving equity (including warrants/carried interest) in issuers on the platform due to concerns about the platform having an incentive to favor some issuers over another. Given that most companies using equity crowdfunding would be cash strapped, this would eliminate a good potential avenue for platforms to get compensated without hurting the issuer’s cash position. The prohibition applied to both broker-dealers and funding portals, which could also discourage some broker-dealers from participating in these offerings. If the SEC loosens these requirements, we are likely to see some equity only fee structures from platforms.
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