Startups can sell ownership stakes in their companies through crowdfunding, under proposed rule changes by the Securities and Exchange Commission (SEC).

The proposed changes would help startups and other small businesses raise money by selling a piece of equity in exchange for funds, to the general public. Traditional avenues of raising capital include banks, venture capitalists, or high-net-worth-individual (HNWI).

The SEC voted unanimously to propose rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding. It is now seeking public comment on the proposed rules for a 90-day period following their publication in the Federal Register.

What are the proposed rules? 

1] A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
2] Investors, over the course of a 12-month period, would be permitted to invest up to:

• $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
• 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000.

3] During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

4] Certain companies would not be eligible to use the crowdfunding exemption. Ineligible companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies, companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.
 
5] As mandated by Title III of the JOBS Act, securities purchased in a crowdfunding transaction could not be resold for a period of one year. Holders of these securities would not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Exchange Act.
 
Disclosure by companies
Consistent with Title III of the JOBS Act, the proposed rules would require companies conducting a crowdfunding offering to file certain information with the SEC, provide it to investors and the relevant intermediary facilitating the crowdfunding offering, and make it available to potential investors.

In its offering documents, among the things the company would be required to disclose:

• Information about officers and directors as well as owners of 20 percent or more of the company.
• A description of the company’s business and the use of proceeds from the offering.
• The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
• Certain related-party transactions.
• A description of the financial condition of the company.
• Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.

Companies would be required to amend the offering document to reflect material changes and provide updates on the company’s progress toward reaching the target offering amount.

Companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.

Crowdfunding Platforms

Crowdfunding transactions need to take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Under the proposed rules, the offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant.

The proposed rules would require these intermediaries to:

• Provide investors with educational materials.
• Take measures to reduce the risk of fraud.
• Make available information about the issuer and the offering.
• Provide communication channels to permit discussions about offerings on the platform.
• Facilitate the offer and sale of crowdfunded securities.

The proposed rules would prohibit funding portals from:

• Offering investment advice or making recommendations.
• Soliciting purchases, sales or offers to buy securities offered or displayed on its website.
• Imposing certain restrictions on compensating people for solicitations.
• Holding, possessing, or handling investor funds or securities.

The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.

What happens now?

The Commission will seek public comment on the proposed rules for 90 days, and will then review the comments and determine whether to adopt the proposed rules.