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SEC Provides Guidance as Crowdfunding Set to Become Effective

Corporate and Securities Alert | February 29, 2016
By: Lori Smith, Bridget Henwood and Michael Psathas

It has been almost four years since Congress passed the Jumpstart Our Business Startups Act (the JOBS Act) and both investors and issuers are eager to begin raising capital through crowdfunding campaigns. Crowdfunding, the process by which companies raise small sums of funds through a large number of investors, will soon be permissible in all 50 states once the SEC’s long awaited rules become effective on May 16, 2016. In anticipation of these changes, the SEC’s Office of Investor Education and Advocacy released an Investor Bulletin (the Bulletin) on February 16, 2016 to educate investors regarding crowdfunding offerings. In the Bulletin, the SEC provided, among other things, an overview of the fundamentals of crowdfunding, the basic mechanics of crowdfunding investing through intermediaries and a discussion of the unique features of crowdfunding offerings.

The SEC affirmed that anyone may participate as an investor in a crowdfunding offering subject to the applicable investment limitations. As discussed in our previous client alerts, investors are limited in how much they can invest during any 12-month period through crowdfunding. The investment cap depends on the investor’s annual income and net worth.[1] An investor whose income or net worth is less than $100,000 can invest up to the greater of: $2,000 or 5% of the lesser of the investor’s annual income or net worth. Alternatively, an investor whose income and net worth are equal to $100,000 or more may invest up to 10% of the lesser of the investor’s annual income or net worth, not to exceed $100,000.

The SEC’s Bulletin also provided guidance on calculating the net worth of an investor for purposes of the investment cap formula. Similar to the net worth rules to qualify as an “accredited investor” for a Regulation D offering, the value of the investor’s primary residence is not included in the net worth calculation for a crowdfunding investor. Notably, a mortgage or other loan on a primary residence that exceeds the fair market value of the home (i.e., a mortgage that is underwater) will count as a liability under the net worth test.

To illustrate the investment limitations applicable to each investor, the SEC provided the following examples in the Bulletin:
 

Income

Net Worth

Calculation

Investment Limit

Investor 1

$30,000

$105,000

Greater of $2000 or 5% of $30,000 ($1,500)

$2,000

Investor 2

$150,000

$80,000

Greater of $2000 or 5% of $80,000 ($4,000)

$4,000

Investor 3

$150,000

$100,000

10% of $100,000

$10,000

Investor 4

$200,000

$900,000

10% of $200,000

$20,000

Investor 5

$1,200,000

$2,000,000

10% of $1,200,000, subject to $100,000 cap

$100,000

Perhaps most significantly, the SEC also dedicated a large portion of the Bulletin to detailing the risks associated with crowdfunding investing. The SEC offered practical guidance and suggested important considerations for potential investors when assessing crowdfunding investments. In particular, the SEC highlighted the following risks:

  • Speculative nature of startup investing and potentially high risk of failure of early-stage ventures
  • Illiquidity due to investor’s inability to resell the investment for one year and the potential difficulty of reselling thereafter
  • Investment cancellation restrictions
  • Difficulty of valuation of startups and potentially limited capitalization
  • Limited disclosures relative to public companies
  • Inability of investor to control offering company’s use of investment proceeds
  • Possibility of fraud
  • Lack of professional guidance from professional investors

It is important to note that while the SEC’s Bulletin did not change or revise any of its previously released rules that the SEC finalized on October 30, 2015, it does contain some helpful guidance for both issuers and investors. The full version of the investor bulletin can be found on the SEC website

For questions or additional information, please contact Lori Smith (smithl@whiteandwilliams.com212.714.3075), Ryan Udell (udellr@whiteandwilliams.com215.864.7152), Bridget Henwood (henwoodb@whiteandwilliams.com212.631.4421) or Michael Psathas (psathasm@whiteandwilliams.com212-868-4833).

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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