September 26th, 2018
What the Proposed US Crowdfunding Rules Could Cost Businesses
A small business that elects to raise money from the masses should prepare for a lifetime of disclosure and fees. According to the recently proposed rules from the Securities and Exchange Commission, a crowdfunded company will have to file annual reports until either all of its crowdfunded securities have been bought out, it goes public or it is dissolved.
This level of transparency may discourage some companies, especially smaller ones, from taking advantage of the new channel for raising money that was designed specifically for them. But critics looking to accuse anonymous bureaucrats of stifling innovation should focus elsewhere: most of the strictures that appear in what will be known as Regulation Crowdfunding, especially those governing the companies that issue securities, come directly from Congress.
The crowdfunding provision, passed as part of 2012’s JOBS Act, allows companies to raise up to $1 million in a 12-month period from the general public under a looser set of rules than what’s normally required in a public offering. But some disclosure obligations remain, depending in part on how much money a company seeks.
A company raising $100,000 or less must provide two years of financial statements, certified by the principal executive, as well as its most recent tax return. Companies raising from $100,000 to $500,000 have to share only the financial statements, but the statements must be reviewed by an independent certified public accountant. Those raising more than $500,000 must have their financials audited.
In its proposed rules, the S.E.C. did modify Congress’s requirements slightly. To determine which tier of financial disclosure a company falls under, it must add the amount it is seeking to the amounts it has already raised through crowdfunded offerings in the previous 12 months. But though many people argued that forcing a young company to provide audited financials would be, as Slava Rubin, chief executive of the crowdfunding site Indiegogo, put it, a “massive deal breaker,” the S.E.C. did not budge.
Financial statements “are generally self-scaling to the size and complexity of the issuer, which reduces the burden of preparing financial statements for many early stage issuers,” the agency explained in its proposal. “We would not expect that the required financial statements would be long or complicated for issuers that are recently formed and have limited operating histories.”
Along with the statements, all crowdfunded companies will have to supply a “narrative discussion of financial results,” similar to the management’s discussion and analysis that a publicly traded company must report.
And beyond financials, the law and the proposed rules require an issuing company to supply fairly detailed information about itself, its executives and the offering. About the offering, for example, a company has to explain how much money it intends to raise, how it plans to use the money, and what happens if it raises more than it expects. It has to identify the people who own more than 20 percent of the business, and it has to describe the business experience in the previous three years of its officers and directors.
While many of these specifics are spelled out in the JOBS Act, the S.E.C. has proposed several additional disclosures, including details about the company’s existing debt, its risk factors and some insider transactions. All told, it’s a fair amount of soul-baring. But apart from the financial statements, companies do have some flexibility about how they present all of this information. Some of it, for instance, could appear in a video or fancy graphic on the crowdfunding website, though a transcription of the video would also have to be filed with the S.E.C.
Once the company has sold its stock (or bonds, as the case may be), much of the required information that was presented at the offering will have to be updated each year in a report filed with the S.E.C. and posted on the company’s website. Eventually — perhaps because its shares have been bought up or because it has gone out of business — the company will have to file a “termination” report with the commission.
Though these requirements are, in fact, much less onerous than those faced by public companies, they will no doubt make crowdfunding a more expensive way to raise capital than some people may have imagined. Regardless of how much a company raises, the S.E.C. estimates that complying with its regulations would cost about $6,500 for the offering and $4,000 for each annual report.