After months of delay, the U.S. Securities and Exchange Commission (SEC) recently issued the highly anticipated rules for crowdfunding efforts aimed at the general public.
Previously limited to accredited investors — those with a net worth of at least $1 million or annual income of more than $200,000 — the proposed rule would allow small businesses to raise up to $1 million a year by tapping unaccredited investors.
The measure would still impose disclosure rules and other requirements on small companies and crowdfunding intermediaries, which some observers say will limit the usefulness of general public crowdfunding for many start-ups. But the proposal did not seek income verification of investors, which some had feared would overburden businesses and dampen the impact of crowdfunding on investment and job creation.
Rory Eakin, COO and founder of crowdfunding platform CircleUp, said he was initially optimistic about the proposal until he read the fine print. “It’s hard to imagine attractive companies will take advantage of these proposed rules,” he said, citing a raft of concerns including a requirement for companies to file financial statements every year.
SEC commissioners say they hope the plan strikes the right balance between facilitating crowdfunding and protecting individuals from fraud. “I believe our proposal is generally careful not to add additional, unnecessary frictions into this marketplace,” SEC Commissioner Daniel Gallagher commented. “That said, the proof is always in the pudding.”
Alon Hillel-Tuch, a co-founder and chief financial officer at RocketHub, a crowdfunding platform that is considering registering with the SEC, said that overall he was optimistic about the SEC’s plan. At the same time, he is concerned about aspects of the proposal, such as a requirement that a company raising more than $500,000 provide an audited financial statement. Some small companies have no historical financials, making it hard to figure out how they would be audited under U.S. accounting standards, Hillel-Tuch said.
To protect investors, companies using crowdfunding will still be required to raise the money through regulated broker-dealers, such as CircleUp, or through crowdfunding portals, a new regulatory category at the SEC.
The number of registered crowdfunding portals or brokers that will operate once the final rules are implemented is unknown. The SEC is estimating anywhere from 50 to 100 brokers and portals could initially seek to enter the space.
Under the SEC’s proposal, crowdfunding portals would be required to provide investors with educational materials and take certain steps to reduce the risk of fraud. Companies using crowdfunding would also have to make some disclosures about their businesses, such as information about officers and directors, how proceeds from the offering will be used, and financial statements.
In addition, the proposal limits how much money an unaccredited investor can contribute each year, based on income. Investors with a net worth and income of less than $100,000 can contribute only $2,000 or 5% of their net worth or income, whichever is greater. Those with a net worth or income of more than $100,000 can contribute more.
Income verification requirements had been a major issue among the small companies expected to rely most on crowdfunding, and the SEC backed off any such requirements. But the SEC plan would require companies using crowdfunding to release financial statements and other information that could prove costly.
Mat Dellorso, the founder and chief executive of WealthForge, a brokerage involved in crowdfunding, said he saw the SEC’s plan as being “middle of the road,” with very few surprises. “Experienced entrepreneurs will have no problem navigating the crowdfunding rules, nor will the intermediaries,” he said. “It is the first-time entrepreneurs that will need help.” The public will have 90 days to respond to the proposed rules, which are hundreds of pages long.