On October 30, the SEC took another shot at legalizing equity crowdfunding, by passing final regulations that are much more streamlined and simpler than the original regulations. The new regulations will take effect sometime next spring or summer, at the earliest.
Under the new regulations, a company can raise a maximum aggregate of $1 million through crowdfunding during a 12-month period. The company must use an SEC-registered intermediary – either a broker-dealer or a funding portal. While the company still must file certain information with the SEC and provide it to investors, the new regulations are more relaxed about the required financial statements. If the offering is between $500,000 and $1 million, the financial statements must be “reviewed” by a public accountant, but they need not be audited (unless audited financials are available). This removes a significant cost barrier that had existed in the previous set of regulations. During any 12-month period, the aggregate amount of securities a company can sell to an investor through all crowdfunding offerings cannot exceed $100,000.
On the investor side, the investment limits for individual investors over a 12-month period, across all crowdfunding offerings, are:
- If either the investor’s annual income or net worth is less than $100,000, he can invest the greater of (a) $2,000 or (b) 5% of the lesser of annual income or net worth
- If both the investor’s annual income and net worth are equal to or greater than $100,000, she can invest up to 10% of the lesser of her annual income or net worth.
So let’s look at Joe Investor, who earns $75,000 per year and has a net worth of $35,000. Since Joe’s net worth is less than his annual income, he can invest the greater of $2000 or 5% of his net worth, which comes to $1750. So in this scenario, Joe can invest $2000 over a 12-month period.
Now let’s look at Melinda Investor, Joe’s much more successful younger sister. Melinda earns $200,000/year, and has a net worth of $350,000. Since her income is less than her net worth, Melinda can invest up to 10% of her $200,000 income, or $20,000.
Securities purchased through a crowdfunding offering generally cannot be resold for one year after purchase.
While the new regulations greatly simplify the process for doing equity crowdfunding, they don’t really address the main problem that faces any startup that wants to use this. How does the company deal with potentially thousands of new stockholders, many of whom may have invested only a few hundred dollars (if that much)? I call these people the Great Unwashed, because beyond a few handfuls of cash, none of these are value-added investors. None will be bringing their expertise and experience to the company, the way a good angel or venture capital investor does. And yet the startup must prepare an annual report that it has to provide to all these stockholders. It also has to hold an annual meeting, notify all these stockholders of the meeting, hold the meeting at a location where these stockholders can attend (if they want), and allow them to vote on various corporate matters, such as the board of directors. Now the company will need to use some of those new funds to hire an investor relations manager, or use an outside service, and will have to devote time to keeping the Great Unwashed happy.