Tuesday, June 25, 2019

Regulation Crowdfunding Study - June 2019

On June 18, 2019, the staff of the SEC issued a report on Regulation Crowdfunding (in short, Regulation CF).  The report presents a summary of the status of crowdfunding as of now, three years after the SEC final rules for Regulation CF became effective.  Although a great initiative, Regulation CF is too complex and costly to be the main securities law exemption behind capital raising in the U.S.

As a way of background, Title III of the JOBS Act added Section 4(a)(6) to the Securities Act, providing for a new exemption from registration for private placements conducted through an online platform.  Regulation CF provides the regulations that put Section 4(a)(6) into practice.  According to Section 4(a)(6) and Regulation CF, a domestic issuer may raise up to $1.07 million in a 12-month period from unaccredited investors provided the issuer prepares certain disclosures, the investors invest only up to a certain maximum based on the investor's income or net worth, and the offering is conducted through a broker-dealer or a registered funding portal.

In summary, Regulation CF did not prove to be as popular as once anticipated.  According to the report, only 1,351 offerings relying on Regulation CF were initiated in 2.5 years between May 16, 2016 and December 31, 2018, and only 519 offerings were reported as completed.  The average amount reported raised per offering was approximately $107,367 for a total of $108.2 million.  In comparison, in 2016 alone, companies in the United Kingdom and China raised $335 million and $460 million, respectively, under similar crowdfunding exemptions.

Most issuers were early in their lifecycle: an average issuer was formed within two years prior to the offering and employed about three people.  Just over half of the offerings were done by issuers with no revenues.  Only about 10% of the issuers became profitable in the most recent fiscal year prior to the offering.  About one-third of the issuers were from California, followed by New York (about 11%) and Texas (about 7%).

The average offering lasted about four months.  About one-half of the issuers offered equity, 27% - debt, and the remaining issuers offered SAFE or another type of investment structure.

Although the $1.07 million limit in Regulation CF offerings was initially much criticized, a typical offering amount was small: the average target amounts ranged between $25,000 and $500,000.   Only 29 offerings reported raising at least $1.07 million during the three-year study period.  Therefore, the low offering limit seems to be appropriate, although one can argue that many potential issuers avoid Regulation CF because of such low limits.   

The SEC staff noted in the report some issuers' lack of compliance with the ongoing filing obligations.  Issuers have to file an annual report on Form C-AR and the final progress update on Form C-U.  Many survey respondents cited the complexity of regulations and Form C as well as high costs associated with Form C and financial statement preparation as the reasons behind such a lack of compliance.

Overall, the report is full of data that should be analyzed with the view of amending Regulation CF.  Then, those issuers that stay away from conducting a Regulation CF campaign due to the low limits, complex and onerous disclosure requirements, necessary audited financials for larger offerings, and ongoing reporting obligations will rely on the Regulation CF in their capital raising efforts and will allow more unaccredited investors to participate in the startup ecosystem.

This article is not legal advice and was written for general informational purposes only.  It does not express anyone else's views except for the author's.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author Arina Shulga.    

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