In a long-awaited decision, the SEC adopted final rules that will allow companies to offer and sell securities through the use of crowdfunding. The final rules represent a reluctant but positive first step by the SEC in allowing companies to take advantage of the potential source of fundraising.
The final rule permits non-reporting U.S. companies to raise $1 million in any rolling 12-month period. Potential investors with an annual income or net worth less than $100,000 can invest the higher of $2,000 or 5% of their annual income or net worth, while those with an annual income or net worth exceeding $100,000 can invest up to 10% of their annual income or net worth but never in excess of $100,000 in a 12-month period.
Nonprofit groups and individuals have been taking advantage of the Internet to raise funds for years. However, companies have been reluctant to use crowdfunding to sell securities, due to the stringent registration process required by Section 5 of the Securities Act of 1933. In order to lessen those requirements and help small businesses and start-ups attract investments and create jobs, Congress passed Title III of the JOBS Act of 2012. Since then, adoption of these rules had been held up, in part over the regulator's concerns that investors could potentially be more easily defrauded online. In setting these limits, the SEC sought to strike a balance between allowing companies access to this new source of capital and creating jobs while also protecting investors.
Although adoption of the crowdfunding rule will be well-received by investors and startups alike, both groups will hope the regulator isn't done yet. Should the adopted rules result in a limited number of fraud cases or failed companies, the SEC could further loosen the restrictions, increase the amount that companies can raise and allow investors to take on greater risk by permitting larger investments.
While the crowdfunding rules grabbed the majority of the headlines, a related SEC announcement is also of interest to fund managers. In several Aug. 6 Compliance and Disclosure Interpretations related to Regulation D of the Securities Act, the SEC expanded on existing guidance regarding the use of general solicitation in attracting capital. The SEC provided guidance that general solicitation is acceptable under certain circumstances, specifically where a "pre-existing, substantive relationship" exists with a prospective investor. Essentially, the issuer must have formed a relationship with prospective investors prior to any solicitation and be sufficiently familiar with their financial status and investment knowledge in order to determine their suitability for the solicitation. Therefore, a fund manager seeking to raise capital for a new fund can avoid general solicitation by reaching out to current and past investors with which it has a pre-existing, substantive relationship to invest in the new fund, and during the offering can create a relationship with accredited or sophisticated investors after commencement of the offering if there is a reasonable waiting period before making the investment.
This represents a loosening of these rules and is consistent with the JOBS Act's intention of helping firms raise money and encouraging economic growth.
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