SEC Adopts Crowdfunding Rules

The Securities and Exchange Committee (SEC) recently voted to adopt a new set of rules that allows for Regulation Crowdfunding (officially, “debt and equity crowdfunding”). Regulation Crowdfunding is a term used to define a middle ground between crowdfunding platforms (like Kickstarter) and public offerings (like IPO’s). While the former sees little regulation, and the latter sees a ton of it, Regulation Crowdfunding sits somewhere in between, and allows small start-ups the chance to raise money while offering securities to investors.

And that is the key: Regulation Crowdfunding is not Kickstarter, where a random person gives you money for a mug, or nothing. But where the new rules really open previously locked doors is their allowance of “unaccredited investors.” Now, essentially anybody can invest at least $2,000 in your start-up. However, investments more than $2,000 are restricted by income and net-worth. And these new rules only apply to funding targets that do not exceed one million dollars.

The new rules also contain other key provisions that start-ups, and potential investors, should be aware of. For one, each offering must include a business plan—so these rules do not apply to “investment vehicles.” Also, investors can change their mind up to 48 hours prior to closing. Part of this rule includes a provision that requires the start-ups to disclose anything that may have a “material impact” on a potential investor’s decision to invest. While the rule does not require first time crowdfunders to pay for an audit, financial records pertaining to your business would certainly fall under the “material impact” rule and should be disclosed to potential investors. Finally, the new rules do not swallow up other avenues of funding. As long as a business keeps themcompletely separate, it can offer both a Regulated Crowdfunding offer, and another offering (like a Title II offering for accredited investors). This allows start-ups to raise money beyond the new one million dollar cap.

While not as onerous as IPO regulations, these new SEC rules are still relatively expansive. In fact, the final rules tip the scales at 685 pages. It’s important for start-ups seeking to raise money under these new rules to understand what they must do to comply, because the full power of the SEC backs their enforcement. If you or someone you know needs help navigating this new regulation, or seeks advice on ways to raise money for a new business, give our Expert Corporate Attorneys a call at 231-714-0100.

The Structure of Regulation Crowdfunding: What the Rules Actually Require

The SEC’s Regulation Crowdfunding rules, codified at 17 C.F.R. Parts 200, 227, and 232, represent a carefully calibrated attempt to make equity crowdfunding viable for small companies while protecting investors from fraud. The rules are built around three key actors: the issuer (the company raising money), the investors (who may be accredited or unaccredited), and the intermediary (a registered broker-dealer or SEC-registered funding portal through which all Regulation Crowdfunding offerings must be conducted).

The original 2016 rules capped annual Regulation Crowdfunding offerings at $1 million. The SEC increased this cap to $5 million in March 2021 as part of amendments designed to make the framework more useful for companies at a meaningful stage of development. The investment limits for individual investors were also adjusted: investors whose annual income or net worth falls below $107,000 may invest the greater of $2,200 or 5% of the lesser of their annual income or net worth; investors above that threshold may invest up to 10% of the lesser of their annual income or net worth, subject to a $107,000 aggregate cap per 12-month period.

The Role of the Funding Portal

One of the most important — and often misunderstood — structural features of Regulation Crowdfunding is the mandatory intermediary requirement. Unlike Title II crowdfunding (which allows direct solicitation of accredited investors), Regulation Crowdfunding requires all transactions to be conducted through an SEC-registered intermediary: either a registered broker-dealer or a registered funding portal. Companies cannot conduct Regulation Crowdfunding offerings directly; they must partner with a qualified intermediary.

The intermediary has substantial regulatory responsibilities, including: conducting background checks on the issuer’s officers, directors, and 20%-or-greater shareholders; reviewing offering materials for compliance with the rules; providing educational materials to investors; implementing measures to reduce fraud risk; and maintaining investor accounts. These requirements are designed to shift some of the investor protection burden from the SEC to the intermediary, which is better positioned to conduct due diligence on individual offerings than a federal regulator reviewing millions of transactions.

For issuers, the choice of funding portal is important. Different portals have different fee structures, investor communities, sector specializations, and marketing capabilities. Due diligence on the portal — its track record, fee disclosure, and regulatory standing — is as important as due diligence on the legal requirements of the offering itself.

Disclosure Requirements: What Issuers Must Tell Investors

Regulation Crowdfunding requires issuers to file a Form C with the SEC and make it available to potential investors through the funding portal. Form C must include:

• Information about the company’s officers, directors, and 20%-or-greater shareholders — including their backgrounds and any prior securities law violations.
• A description of the business and intended use of proceeds with reasonable specificity. The SEC’s “material impact” rule requires disclosure of anything that might affect an investor’s decision — which in practice means known risks, competitive landscape, regulatory challenges, and anything else that a reasonable investor would consider material.
• Financial statements. For offerings up to $124,000, financial statements must be signed by the principal executive officer. For offerings between $124,000 and $618,000, the statements must be reviewed by an independent public accountant. For offerings above $618,000, full audited financial statements are required — a significant cost for early-stage companies seeking to raise under $1 million.
• A description of the offering terms, the type of securities being offered, target offering amount, deadline to reach the target, and whether the company will accept oversubscriptions.

Investor Protections and the 48-Hour Withdrawal Right

The 48-hour withdrawal right described in the original post reflects an important investor protection built into Regulation Crowdfunding. Investors may cancel their commitment for any reason up to 48 hours before the deadline for the closing of the offering. Additionally, if the issuer makes a material change to the offering terms — changes to the use of proceeds, pricing, or other material terms — investors who previously committed must be notified and given the opportunity to reaffirm or cancel their commitment.

The escrow requirement is another key protection: investor funds are held in escrow by the intermediary until the offering reaches its minimum target amount. If the target is not reached by the offering deadline, all investor funds are returned. This protects investors against funding companies that fail to raise enough capital to execute their business plans — a risk that is particularly acute for early-stage companies whose viability depends on reaching a critical funding threshold.

Post-Offering Obligations

The compliance obligations for Regulation Crowdfunding issuers do not end when the offering closes. Companies that successfully raise money under Regulation Crowdfunding must file annual reports with the SEC on Form C-AR disclosing updated financial statements and material changes in the company’s business. These annual reporting obligations continue until one of several termination events: the company files a Form 10-K (meaning it has become a reporting company under the Exchange Act); the company has fewer than 300 shareholders of record and less than $10 million in total assets; or the securities are fully transferred or repurchased.

The ongoing reporting obligations are a significant compliance burden for small companies. Before deciding to raise money through Regulation Crowdfunding, companies should factor in the cost of SEC filings, intermediary fees, accounting fees for financial statement review or audit, and ongoing annual reporting obligations — not just the regulatory compliance cost of the initial offering.

Regulation Crowdfunding vs. Other Funding Mechanisms

Regulation Crowdfunding is one of several SEC-regulated frameworks for raising capital from investors. The choice among them depends on the company’s target investors, deal size, and compliance capacity:

• Regulation D, Rule 506(b). Allows unlimited raises from accredited investors, with up to 35 sophisticated non-accredited investors. No general solicitation permitted. No SEC filing of offering documents, only a Form D notice.
• Regulation D, Rule 506(c). Allows unlimited raises from verified accredited investors only, with general solicitation and advertising permitted. Requires verification of accredited investor status.
• Regulation A+, Tier 2. Allows raises of up to $75 million in a 12-month period from both accredited and unaccredited investors with full SEC qualification review. A mini-IPO alternative for companies seeking meaningful scale.
• Regulation Crowdfunding. Allows raises of up to $5 million from unaccredited investors through registered intermediaries. Best suited for early-stage consumer-facing businesses with an existing community of potential investors.

Talk to an Attorney

Selecting the right capital raising framework, preparing a compliant offering, and managing ongoing reporting obligations are complex legal matters that require experienced securities counsel. Mistakes in securities offerings — misstatements, omissions, or improper conduct — can result in rescission liability, SEC enforcement action, and private lawsuits from investors. Revision Legal’s corporate attorneys advise startups and growth-stage companies on Regulation Crowdfunding and other exempt offering frameworks. Contact us through the form on this page or by calling 855-473-8474.