JOBS Acts Title III that allows non-accredited investors to involve into equity crowdfunding didn't pass in 2014, and was expected to extend to 2016. In order to eliminate the confusions about equity crowdfunding rules, we spoke with an equity crowdfunding law expert Alixe Cormick, the founder of Venture Law Corporation in Vancouver, British Columbia. She is a member of the Advisory Board of the National Crowdfunding Association of Canada.
Q: Why the Title III of the JOBS ACT delayed?
A：The title III crowdfunding exemption in the Job's Act blurs the lines between what is a public company and private company. It questions the existing securities law system requiring audited financial statements, detailed disclosure, and the use of gatekeepers to filter who gets access to capital and who does not as a public company and private company. The existing private placement rules encourage investment from a small group of people who are knowledgeable about the business and the individuals raising capital, or have an income or asset base that affords them a certain level of sophistication and ability to bear a financial loss if things do not work out. Equity crowdfunding expands the traditional pool of private placement investors while requiring minimal disclosure in comparison to a prospectus offering or Regulation A offering. Anyone can invest under the Title III crowdfunding exemption. Investment is not limited to investors who have first-hand knowledge about the business or management, or have the financial means to weather the loss of their entire investment if things go wrong.
As you can imagine, if fundamental principles and beliefs are being challenged by a rule which the equity crowdfunding does, it requires a full examination. Those entrenched in the existing system are reluctant to accept any rule that changes the status quo. As far as they are concerned the existing system is working. They are also concerned about the level of fraud and failure equity crowdfunding will bring into the marketplace and their ability to police fraud and educate the public about risk and failure. Start-up companies have a high fail rate. Not all investors may understand they are more likely to lose all their money than make any return. Regulators are concerned about protecting investors who are at risk of losing all their investment funds.
Q: Is Regulation A+ Title IV a breakthrough for non-accredited investors to invest or small companies to fund?
A: Regulation A+ is going to transform how capital is raised by small issuers in the US and who invests in private companies. Until I read the new rule in full I was concerned that it would not be useful at all to small issuers. The rule in its present form will not be used by start-ups or even early stage companies. The cost of preparing US GAAP audited financial statements, an offering circular, and ongoing disclosure requirements is too costly for most start-up and early stage companies. Only the ambitious few in this group will elect to use Regulation A+ to raise capital. The rule will however, be very useful to companies in the growth and expansion phases and companies in specialty areas like biotech that need lots of capital to advance to their next milestone.
Regulation A+ has always allowed advertising. The old cap of $5 million would satisfy most start-up and growth companies initial needs. The problem was the cost of preparing the required Regulation A+ documents and the requirement to have Regulation A offering documents vetted by state regulators who applied their own requirements and conducted a merit review.
Tier 1 of Regulation A+ is available to issuers raising up to $20 million. Tier 1 requires reviewed financial statements only. There are no ongoing disclosure requirements. The offering documents, however, must be reviewed by state securities regulators as well as the SEC. It is essentially the old rule with a higher cap.
Tier 2 of Regulation A+ pre-empts state review of the offering documents and is available to issuers raising $1 to $50,000,000. Tier 2 requires audited financial statements and an agreement to provide ongoing disclosure including a six month unaudited financial statement and another year end audit financial statement for one year after the offering concludes.
The new rules have a built in regulatory experiment. Specifically, will issuers prefer to provide audited financial statements and ongoing disclosure as a Tier 2 to avoid state blue sky review when raising under $20 million? Or, does the ability to provide reviewed financial statements with no ongoing disclosure obligation provide enough of an incentive for issuers to use Tier 1 even if they are subject to a blue sky review? There are, of course, a number of other issues that clouds this type of evaluation. The investors or the broker-dealer engaged to sell the securities may demand audited financial statements in these offerings. Canadian issuers who are not reporting issuer in the US but reporting issuers in Canada already prepare audited financial statements and provide ongoing disclosure. Issuers who already have venture capital or institutional investors likely have audited financial statements and make ongoing disclosures similar to those required. Etc.
Fundrise has been using the existing Regulation A to crowdfund in the US for over two years now. They have paved the way so to speak for other real estate issuers to similarly use Regulation A+. With over 85 real estate crowdfunding platforms you should see an explosion in the use of Regulation A+ by this segment of crowdfunders.
How useful Regulation A+ will be to issuers and investors is yet to be determined. There are a number of different constituent groups that need to buy into the value proposition Regulation A+ potentially offers: issuers, investors, broker-dealers; legal counsel; accountants and auditors. This takes time and education. Also, broker-dealers are still subject to know your product, know your client, and client suitability rules. Stock of small private issuers is risky and not suitable for 80% or more of the investors out there. Regulation A+ does not solve the suitability issue of the stock being sold. High risk stock should only ever make-up a small percentage of any investors portfolio and some investors should have no securities in this category given their age and risk aversion.
Q：What rules start-ups need to pay attention to before undertaking an online campaign?
A：All companies raising capital need to understand the requirements of the particular securities law exemption they intend to rely on to sell their securities in a promotional online campaign. For example:
- Is the exemption a federal securities exemption that pre-empts the need for a state securities exemption as well? If yes: Is it self-executing or do you need to do something before or after the campaign to rely on the exemption federally or in a particular state(s)? If no: Is there a matching state exemption or a different exemption you can rely on in the state(s) you plan on conducting the online campaign?
- Does the exemption include an exemption from the need for the selling agent to be registered? If yes: Is it self-executing or do you need to do something before or after the campaign to rely on the exemption federally or in a particular state(s)? If no: Have you engaged a broker dealer? Is there an exemption from registration at the state level the selling agents can rely on? (A number of states require directors and officers to register as selling agents prior to an online campaign they are conducting if a registered broker dealer has not otherwise been engagedor the company intends to conduct direct sales as well as brokered sales.)
- Does the exemption allow advertising? If yes: (1) What forms of advertising? (2) Is there any content restrictions or disclosure requirements? (3) Do you need to vet or file any advertising or marketing materials in advance or after use? (4) Who can advertise? Company? Platform? Registered broker dealer?
- Are there any pre-filing requirements related to this exemption? If yes: (1) Are there any specific forms required to be filed? (2) Do you need to prepare and provide an offering document? (3) Do you need to prepare and provide audited or reviewed financial statements?
- Are there any bad actor restrictions applicable to who can use this exemption? If yes: (1) Canvas management and everyone involved in the campaign to ensure you can use the exemption. (2) If you have a "bad actor" confirm whether or not you may be able to obtain a waiver for this person's involvement or if you can terminate their relationship with the company in order to rely on the exemption.
Review all campaign materials including: written, oral, and video with legal counsel for anything offside in securities laws, either related to the specific exemptions or in general. Anti-fraud rules always apply when raising capital. Certain statements invite regulatory action and should be avoided.