Technology Companies Group Alert
May.27.2020
On May 4, 2020, the SEC adopted temporary final rules, in light of the effects of the COVID-19 pandemic, that eased Regulation Crowdfunding requirements in order to make it easier for small businesses to raise money through regulation crowdfunding. The SEC stated that “in the current environment, many small businesses are facing challenges accessing urgently needed capital in a timely and cost-effective manner. A securities offering under Regulation Crowdfunding offering of securities may be an attractive fundraising option for some small businesses at this time….” The amendments apply to securities offerings initiated under Regulation Crowdfunding between May 4, 2020, and August 31, 2020.
The purpose of the temporary relief is to make it easier for issuers who meet certain eligibility criteria to assess interest in a crowdfunding offering prior to preparing full offering materials, and to close an offering sooner than would typically be possible. The temporary relief also provides an exemption from certain financial statement review requirements for issuers offering $250,000 or less within a 12-month period.
Issuers must meet existing eligibility criteria[1] and cannot have been organized and operating less than six months prior to the commencement of the offering. Issuers who have sold securities in a Regulation Crowdfunding must have complied with the requirements of Section 4A(b) of the Securities Act and the related rules.
Issuers may initially omit financial statements from their filing of an offering statement if the financial statements are not otherwise available. This relief is intended to help businesses that have urgent funding needs but do not have current financial statements available or are facing challenges obtaining reviewed or audited financial statements due to COVID-19; it also acknowledges that issuers may be reluctant to undertake the cost of having such statements prepared without having an indication their offering will succeed. However, the financial statements will be required to be included by amendment and provided to investors and the intermediary before the intermediary accepts any investment commitments in the offering, potentially significantly limiting the effectiveness of the temporary relief if financial statements take a significant amount of time to complete. A company relying on the temporary relief must prominently disclose under temporary Rule 201(z) of the Securities Act that the omitted financial information is not otherwise available and will be provided by an amendment to the offering materials, that the investor should review all of the offering materials, including previously omitted financial information, prior to making an investment decision, and no investment commitments will be accepted until such financial information has been provided.
Seeking to mitigate the difficulties in obtaining reviewed or audited financial statements due to COVID-19, under the temporary rules issuers raising between $107,000 and $250,000 in a 12-month period may provide financial statements certified by the principal executive officer, rather than statements reviewed by a public accountant independent of the issuer, as is normally required (Regulation Crowdfunding previously allowed companies to raise up to only $107,000 with financial statements and tax information certified by the company’s principal executive officer). However, if financial statements reviewed or audited by a public accountant independent of the issuer are available, they must be provided.
Sales are permitted as soon as an issuer has received a binding investment covering the target offering amount. However, the commitments are not binding until 48 hours after they are given. Previously sales were permitted only after the information in the offering statement was publicly available for at least 21 days. An early closing is permitted as soon as binding commitments are received and reach the target amount so long as (1) the issuer has complied with the disclosure requirements in temporary Rule 201(z), (2) the intermediary provides notice that the target offering amount has been met, and (3), at the time of the closing of the offering, the issuer continues to meet or exceed the target offering amount. Under the temporary relief, investors may cancel their investment commitment for 48 hours after making the commitment. After that time period, they may only cancel unless there is a material change to the offering. Additionally, a company must provide prominent disclosure that the offering is being conducted on an expedited basis due to circumstances relating to COVID-19.
Any issuer relying on the temporary rules must provide a prominent and clear disclosure that the offering is being conducted on an expedited basis due to circumstances relating to COVID-19 and pursuant to the SEC’s temporary regulatory COVID-19 relief (in addition to any requirements described above). The temporary relief is effective from May 4, 2020, through March 1, 2021, for securities offerings initiated under Regulation Crowdfunding between May 4, 2020, and August 31, 2020. The SEC indicated that they may choose to extend the time period for which this relief applies if they deem it appropriate, and they could add additional conditions or issue other relief.
Companies seeking to raise money pursuant to Regulation Crowdfunding are typically newly formed, early stage companies with limited assets and limited revenue, if any. This method of investment, typically conducted over the internet, is aimed at assisting smaller companies with capital formation by accessing a greater pool of potential investors. This profile means these issuers are not able to raise capital through traditional fundraising routes (or are not willing to incur the related expense). Regulation Crowdfunding is viewed as a low-cost method for startups to sell securities broadly to the public, including nonaccredited investors, but lacks the certainty of more traditional private placements. Regulation Crowdfunding requires companies to engage intermediaries in order to conduct the offering. Intermediaries can be either broker-dealers or funding portals, but both have to register with FINRA and the SEC. As a result of the low fundraising threshold of $1.07 million, on March 4, 2020, the SEC announced that it was considering changes that would raise the maximum amount that can be raised in a crowdfunding offering to $5 million, in effect removing investment limits on accredited investors and making it easier for non-accredited investors to calculate the limits on their investments. It is uncertain when a final rule will be released by the SEC or if the final rule will be revised. More companies may decide to pursue crowdfunding as a method to raise capital as a result of the temporary relief by decreasing the public audit barrier, at least temporarily, and to potentially access capital more quickly.
A helpful chart from the SEC outlining the temporary rules is available in this SEC press release.
Please contact any member of Orrick’s Technology Companies Group for assistance with any crowdfunding or related offering questions.
[1] The temporary exemption is not available to companies that are disqualified under Regulation Crowdfunding’s disqualification rules, reporting companies, non-U.S.-based issuers, investment companies, blank check companies and companies that have failed to file annual reports as required by Regulation Crowdfunding during the two years immediately prior to commencement of the offering.