Several weeks ago, we explained that the SEC’s proposed crowd funding rules may make financing your start-up via websites like Kickstarter more time consuming and expensive than is necessary. On October 23, 2013, the SEC clarified and proposed additional crowd funding rules, which, while not as onerous as they might have been, are still far from perfect (and may not be as good as the current financing rules).
The highlights of the new rules are as follows:
- The company would be able to raise a maximum aggregate amount of $1 million through crowd funding offerings in a 12-month period.
- Crowd funding transactions must take place through an SEC-registered intermediary, either a broker-dealer or a funding portal.
- The company would have to make the following pre-financing disclosures:
- If the company is offering $100,000 or less of securities, it must provide tax returns and financial statements certified by a company executive.
- If the company is offering between $100,000 and $500,000 of securities, it must provide financial statements that are reviewed by an independent public accountant.
- If the company is offering more than $500,000 of securities, it must provide audited financial statements.
- The Company must file an annual report and provide it to investors.
Under these rules, a start-up company looking to raise $200,000 to $300,000 of early seed capital would be better off, in my opinion, doing a standard Regulation D offering to friends and family or angel investors. Let’s look at that situation under the two scenarios.
With the crowd funding rules, the start-up may have access to a larger group of potential investors, but this advantage comes with a requirement for financial statements reviewed by an accountant, an obligation to file annual reports with the SEC, and a requirement that the start-up use an SEC registered funding portal, which will take a fee.
Under a standard Regulation D offering, no financial statements (reviewed, audited or otherwise) are required, there is no limit on the amount that can be raised, there are no required annual reports and there is no required funding portal. Really, the only downside is that such a financing would be limited to only 35 non-accredited investors (individuals with a high salary or net worth), but what is the likelihood that a non-accredited investor could cut the start-up a significant check anyway?
If the start-up wants access to a larger pool of potential investors, instead of crowd funding, it should do a general solicitation under Regulation D. This allows the start-up to advertise its fundraising (via website, broadcast or print media) so long as it only sells securities to accredited investors. This would require some work to confirm the investor is accredited, but it doesn’t involve the disclosure and filing requirements of crowd funding.